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D O D G E & C O X
Income Fund
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Dodge & Cox
Investment Managers
35th Floor
One Sansome Street
San Francisco
California 94104
(415) 981-1710
For Fund literature and information, please call:
(800) 621-3979
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This report is submitted for the general information of the shareholders of the
Fund. The report is not authorized for distribution to prospective investors in
the Fund unless it is accompanied by an effective prospectus.
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D O D G E & C O X
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Income Fund
Established 1989
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Quarterly Report
September 30, 1997
1997
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[RECYCLE LOGO APPEARS HERE] Printed on recycled paper. 9/97 IF QR
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D O D G E & C O X
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Income Fund
To Our Shareholders
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The Dodge & Cox Income Fund provided a total return of 3.7% for the quarter
ended September 30, 1997. The total return for the Lehman Brothers Aggregate
Bond (LBAG) Index (a broad-based index composed of investment grade bonds) was
3.3% for the same period. For the first nine months of 1997 the Fund returned
6.7%, compared to a 6.6% return for the LBAG Index. Average annual total returns
for longer time periods are listed on page three of this report.
Interest Rates Finish Lower After a Volatile Quarter
Signs of controlled growth and lower inflation led to an overall decline in
interest rates for the quarter, but mixed economic signals contributed to some
intra-period volatility. A strong July unemployment figure of 4.8%, the lowest
in over two decades, and higher-than-expected growth in manufacturing put upward
pressure on interest rates. In contrast, reports on retail sales and consumer
prices pointed to slower economic growth and lower inflation, reining in fears
that rising prices would erode the value of fixed income securities.
The net effect was a decline in interest rates. From June 30, the yield on the
30-year U.S. Treasury dropped 38 basis points to 6.40% (one basis point equals
1/100 of one percent). Similar declines occurred across the term structure:
five-year U.S. Treasury yields fell 39 basis points and one-year Treasury Bill
yields registered a 21 basis point decline.
Income contributed roughly 1.8% to the Fund's total return, while price
appreciation contributed approximately 1.9%, for a total return of 3.7%. Price
appreciation was a major factor in total return because interest rates finished
the quarter significantly lower.
Fixed Income Investment Philosophy and Process
At Dodge & Cox, we believe that the income component of return, and its
reinvestment, are the most important contributors to the total return of fixed
income investments over long time periods. While price changes due to interest
rate movements can dominate bond returns over short time periods, our analysis
underscores the importance of income to long-term relative performance. With
this in mind, we seek a higher yielding portfolio than the broad domestic fixed
income market by maintaining overweight positions in the corporate and federal
agency mortgage-backed sectors. We attempt to maintain a high average quality by
building the portfolio through a careful process of individual security
selection based on independent fundamental research.
Our analysis of fixed income securities incorporates a careful study of the
credit risk and cash flow structure of each bond to determine if the offered
yield represents adequate compensation for investors. All primary research and
analysis is performed by our portfolio managers and by our in-house security
analysts. These research capabilities give us greater confidence in individual
investment decisions and allow us to take a longer-term perspective when
investing the Fund's assets. An example of the key role fundamental research
plays in our security selection process is the Fund's purchase of $6.5 million
par value of U.S. Government-guaranteed Development Company Participation
Certificates (DCPCs).
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D O D G E & C O X
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Income Fund
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U.S. Government-Guaranteed Development Company Participation Certificates
DCPCs are pools of fixed-rate debentures that are collateralized by 20-year
loans made to existing small businesses. These loans are fully-amortizing and
used for the purchase of plant and property. The principal and interest payments
on both the underlying loans and the debentures are backed by a Small Business
Administration guarantee, which qualifies as a full faith and credit guarantee
of the U.S. Government./1/
We believe these securities offer a significant yield advantage relative to U.S.
Treasuries without sacrificing credit quality or adversely impacting overall
cash flow stability. Our analysis shows that DCPCs have, on average, exhibited
low levels of voluntary prepayments across a wide range of interest rate
scenarios. This cash flow stability is due to a number of factors, including an
onerous prepayment penalty that is assessed over the first half of each loan's
life. The penalty serves to deter early principal payments by borrowers and,
because it is passed through to investors, helps to mitigate the impact on total
return if early prepayments must be reinvested in a declining interest rate
environment. Our research into the DCPC program has given us confidence in the
cash flow stability of these securities and has provided a framework in which to
analyze their relative value.
In Closing
We believe that our ongoing commitment to independent fundamental research and
individual security selection will continue to benefit Fund shareholders in the
years ahead. Thank you for your continued confidence in the Dodge & Cox Income
Fund. As always, we welcome your comments and questions.
For the Board of Directors,
/s/ A. Horton Shapiro
October 24, 1997 A. Horton Shapiro, President
/1/ Certain individual fixed income securities owned by the Fund, but not shares
of the Fund, are guaranteed by the U.S. Government as to timely payment of
principal and interest.
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D O D G E & C O X
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Income Fund
Objective The Fund's primary objective is to provide shareholders with a
high and stable rate of current income, consistent with
long-term preservation of capital. A secondary objective is to
take advantage of opportunities to realize capital
appreciation.
Strategy The Fund seeks to achieve these objectives by remaining fully
invested in a diversified portfolio of primarily high quality
bonds and other fixed income securities, while striving to
maintain the Fund's yield higher than that of the broad bond
market. Dodge & Cox conducts thorough fundamental research on
each of the Fund's investments, taking many factors into
consideration including creditworthiness and structural
characteristics. Fixed income securities in the Fund will
generally include U.S. Treasury, mortgage-related and corporate
issues.
Investment Performance Since Inception through September 30, 1997
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[LINE GRAPH APPEARS HERE]
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<CAPTION>
Dodge & Cox LBAG
Year Income Fund Index
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<S> <C> <C>
1/1/1989 10,000 10,000
12/31/1989 11,411 11,455
12/31/1990 12,256 12,482
12/31/1991 14,451 14,479
12/31/1992 15,581 15,550
12/31/1993 17,350 17,067
12/31/1994 16,848 16,568
12/31/1995 20,252 19,630
12/31/1996 20,988 20,339
9/30/1997 22,388 21,670
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<TABLE>
<CAPTION>
8.75 Years
Average annual total return for periods ended September 30, 1997 1 Year 5 Years (Since Inception)
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<S> <C> <C> <C>
Dodge & Cox Income Fund 10.13% 7.52% 9.65%
Lehman Brothers Aggregate Bond Index 9.74 6.92 9.24
</TABLE>
The chart covers the period from January 1, 1989 to September 30, 1997. It
compares a $10,000 investment made in the Dodge & Cox Income Fund to a $10,000
investment made in the Lehman Brothers Aggregate Bond (LBAG) Index. The Fund's
total returns include the reinvestment of dividend and capital gain
distributions. The LBAG Index is a broad-based unmanaged measure of
investment-grade corporate and U.S. Government fixed income securities. Index
returns include interest income and, unlike Fund returns, do not reflect fees or
expenses. Past performance does not guarantee future results. Investment return
and share price will fluctuate with market conditions, and investors may have a
gain or loss when shares are sold.
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Income Fund
Fund Information September 30, 1997
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General Information
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<S> <C>
Net Asset Value Per Share $11.88
Total Net Assets (millions) $660
1996 Expense Ratio 0.50%
1996 Portfolio Turnover 37%
30 Day SEC Yield* 6.45%
Quarterly Distribution to Shareholders
of Record 9/25/97 (per share): $0.19 Dividend
Fund Inception Date 1989
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Investment Manager: Dodge & Cox, San Francisco.
Managed by ten-member Bond Strategy Committee, with
members' average tenure at Dodge & Cox of 11 years.
Bond Characteristics
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<TABLE>
<S> <C>
Number of Bonds 91
Average Quality AA+
Average Maturity 12.5 years
Effective Duration 5.18 years
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Moody's/Standard & Poor's
Quality Ratings % of Fund
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<TABLE>
<S> <C>
U.S. Government & Government Agencies 58.1
Aaa/AAA 3.9
Aa/AA 4.0
A/A 17.8
Baa/BBB 12.4
Ba/BB 0.7
Short-Term Investments 3.1
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Asset Allocation
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[PIE CHART APPEARS HERE]
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<S> <C>
Bonds: 96.9%
Short-Term Investments: 3.1%
</TABLE>
Sector Breakdown % of Fund
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<S> <C>
U.S. Treasury and Government Agency 18.9
Federal Agency CMO and REMIC+ 18.5
Federal Agency Mortgage Pass-Through 20.7
Corporate 32.8
Foreign (U.S. Dollar-denominated) 6.0
Short-Term Investments 3.1
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+ Collateralized Mortgage Obligation and
Real Estate Mortgage Investment Conduit
Maturity Breakdown % of Fund
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<S> <C>
0-1 Years to Maturity 7.7
1-5 41.7
5-10 17.7
10-15 4.6
15-20 4.4
20-25 10.3
25 and Over 13.6
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*An annualization of the Fund's total net investment income per share for the
30-day period ended on the last day of the month.
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Income Fund
Portfolio of Investments September 30, 1997
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<TABLE>
<CAPTION>
PERCENTAGE OF FUND
<S> <C>
BONDS: 96.9%
U.S. TREASURY & GOV'T AGENCY: 18.9%
FEDERAL AGENCY CMO AND REMIC+: 18.5%
FEDERAL AGENCY MTG. PASS-THROUGH: 20.7%
CORPORATE: 32.8%
INDUSTRIAL: 18.3%
Lockheed Martin Corp., various securities .............................. 2.9
Dayton Hudson Corp., various securities ................................ 2.9
Walt Disney Co. Debentures 7.55%, 7/15/2093, Callable 2023 ............. 2.4
Ford Motor Co. Debentures 8 7/8%, 1/15/2022 ............................ 2.0
May Department Stores Debentures, various securities ................... 2.0
Raytheon Co., various securities ....................................... 1.9
General Motors Corp. Debentures 7.70%, 4/15/2016 ....................... 1.5
Time Warner Ent. Sr. Debentures 8 3/8%, 7/15/2033 ...................... 1.3
Ford Holdings, Inc. Debentures 9 3/8%, 3/1/2020 ........................ 0.9
Union Camp Corp. Debentures 9 1/4%, 2/1/2011 ........................... 0.5
FINANCE: 12.0%
Norwest Corp., various securities ...................................... 2.9
Hartford Financial Services Group, various securities .................. 1.8
General Electric Capital Debentures 8.85%, 3/1/2007 .................... 1.8
GMAC Put Notes 8 7/8%, 6/1/2010, Putable 2000/2005 ..................... 1.4
J.P. Morgan Capital Trust I, 7.54%, 1/15/2027, Callable 2007 ........... 0.9
BankAmerica Capital II, 8%, 12/15/2026, Callable 2006 .................. 0.9
Citicorp Capital Trust I, 7.93%, 2/15/2027, Callable 2007 .............. 0.9
First Nationwide Bank Subordinated Debentures 10%, 10/1/2006 ........... 0.7
Barclays No. Am. Capital 9 3/4%, 5/15/2021, Callable 2001 .............. 0.2
Citicorp Capital Trust II, 8.015%, 2/15/2027, Callable 2007 ............ 0.2
CIGNA Corp. Notes 7.65%, 3/1/2023 ...................................... 0.2
Banamex Exp. Funding Coll. Notes Series K, 5.74%, 10/15/1997 ........... 0.1
TRANSPORTATION: 2.2%
Consolidated Rail Corp. Debentures 9 3/4%, 6/15/2020 ................... 1.1
Norfolk Southern Bonds 7.70%, 5/15/2017 ................................ 0.9
Norfolk & Western R.R. Equip. Trust Cert., 10 1/8%, 7/1/2000 ........... 0.1
Seaboard Coast Line R.R. Equip. Trust Cert., 11 1/4%, 3/1/1999 ......... 0.1
UTILITIES: 0.3%
Idaho Power Co. 1st Mtg. Bonds 9 1/2%, 1/1/2021, Callable 2001 ......... 0.3
FOREIGN (U.S. DOLLAR-DENOMINATED): 6.0%
CANADIAN CORPORATE: 4.0%
Hydro-Quebec, various securities ....................................... 2.7
Canadian Pacific Ltd. Debentures 9.45%, 8/1/2021 ....................... 1.3
INTERNATIONAL AGENCY: 2.0%
Inter-American Dev. Bank 7 1/8%, 3/15/2023, Callable 2003 .............. 1.3
European Investment Bank Notes 10 1/8%, 10/1/2000 ...................... 0.7
SHORT-TERM INVESTMENTS: 4.0%
OTHER ASSETS LESS LIABILITIES: (0.9%)
TOTAL NET ASSETS: 100.0%
</TABLE>
+ Collateralized Mortgage Obligation and
Real Estate Mortgage Investment Conduit
The financial information has been taken from the records of the Fund and has
not been audited by our independent accountants who do not express an opinion
thereon. The financial statements of the Fund will be subject to audit by our
independent accountants as of the close of the calendar year.
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Income Fund
General Information
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Investment Since 1930, Dodge & Cox has been providing professional
Manager investment management for individuals, Manager trustees,
corporations, pension and profit-sharing funds, and charitable
institutions. Dodge & Cox manages the Dodge & Cox Income Fund,
the Dodge & Cox Balanced Fund and the Dodge & Cox Stock Fund.
No-Load Fund Shares of the Fund are purchased and redeemed at net asset
value. There are no sales, redemption or rule 12b-1 plan
distribution charges.
Gifts Fund shares provide a convenient method for making gifts to
children and to other family members. Shares may be held by an
adult custodian for the benefit of a minor under a Uniform
Gifts/Transfers to Minors Act. Trustees and guardians may also
hold shares for a minor's benefit.
Automatic Shareholders may make regular monthly or quarterly investments
Investment of $100 or more through Investment Plan automatic deductions
Plan from their bank accounts.
Withdrawal Shareholders owning $10,000 or more of the Fund's shares may
Plan elect to receive periodic monthly or quarterly payments of at
least $50. Under the plan, all dividend distributions are
automatically reinvested at net asset value with the periodic
payments made from the proceeds of the redemption of sufficient
shares.
Reinvestment Shareholders may direct that dividend and capital gains
Plan distributions be reinvested in additional Plan Fund shares. The
above plans are completely voluntary and involve no service
charge of any kind.
IRA Plan The Fund has an Individual Retirement Plan (IRA) available for
shareholders of the Fund.
Shareholder Fund literature and details on all of these Plans are available
Inquiries from the Fund upon request.
Dodge & Cox Income Fund
c/o Firstar Trust Company
P.O. Box 701
Milwaukee, Wisconsin 53201-0701
(800) 621-3979
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