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Dodge & Cox Funds 2015 Fixed Income Mid-Year Review

Dodge & Cox Funds fixed income mid-year review.

Dodge & Cox Funds 2015 Fixed Income Mid-Year Review - Transcript

Tom Dugan: So Dana, let’s discuss fixed income markets in the first half of 2015, particularly the factors that influenced returns that bonds generated over this time period. And secondary of interest, particularly among our clientele and other market participants, is interest rates generally as well as the state of credit markets, which have been quite dynamic lately. So how would you characterize fixed income markets over the course of the first half?

Dana Emery: The first half of 2015 was a tough environment for fixed income as interest rates rose and returns were essentially flat. But it’s really a tale of two quarters. The first quarter was characterized by very negative economic growth, declining interest rates, and very strong returns from fixed income securities. And then that was essentially reversed in the second quarter as economy improved, interest rates rose, and there were significantly negative total returns in fixed income. It was a period where ten-year Treasury rates during the second quarter rose to almost 2.4% by quarter end, so a significant rise and negative price movements associated with that. In addition, the market began to price in an increase in federal funds target rate later this year. Interest rate volatility picked up significantly over a very benign volatility environment last year. Some of this was due to concerns about Greece potentially exiting the Eurozone, concerns about a China slowdown and the feed-through into global economic growth due to their frothy equity markets. In addition, the oil prices declined precipitously earlier this year and seemed to languish. And then the dollar was very strong and the impact of that on economic growth is of concern. We saw the credit markets reprice significantly over the past year. The basis points premium over Treasuries increased by about 50%, so up to 150 basis points by quarter end. That was due to a releveraging of corporate America moderately as well as M&A activity and a lot of that was debt financed. And we also saw a mix shift, that banks are issuing a greater percentage of subordinated bank debt in order to get ahead of impending Dodd Frank legislation. The mortgage market, which is a significant component of the broad investment grade bond universe, performed very well relatively due to their high quality, their short duration, and a relatively benign prepayment environment.

Tom Dugan: With that market backdrop, the Dodge & Cox Income Fund produced a small positive return, about ten basis points, and the broad market a small negative return, minus ten basis points. There are really four key factors driving some of that relative performance advantage. The first is on interest rate risk we are more defensively positioned, vis-à-vis interest rate risks. And what that means is that as rates rise the portfolio doesn’t do as poorly as the broader market and that was certainly the case over the first half of the year. Secondly, specific issues that we feature in the portfolio have relatively strong performance. Two Brazil related holdings, Petrobras and an asset-backed security called the Rio Oil Trust – these are U.S. dollar denominated bonds, of course – had really strong performance in the first half, bouncing back from a really weak second half of 2014. Two other corporate bonds had relatively strong performance: Cemex, the Mexico City headquartered global cement company, as well as Telecom Italia. A third...