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DODGE & COX
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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DODGE & COX
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Income Fund
Established 1989
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Quarterly Report
March 31, 1997
1997
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DODGE & COX
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Income Fund
Fellow Shareholders
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The Dodge & Cox Income Fund had a total return of -0.8% for the quarter ended
March 31, 1997. The total return for the Lehman Brothers Aggregate Bond Index
(LBAG) was -0.6% for the same period. Average annual total returns for longer
time periods are summarized on page three of this report.
The Federal Reserve Moves to Raise Rates
The first quarter of 1997 was marked by rising interest rates and a
corresponding decline in bond prices. Interest rates rose partly in response
to: perceptions of an accelerating U.S. economy, hints by Federal Reserve
Chairman Alan Greenspan of the likelihood of a Federal Funds rate increase, and
the Fed's actual 25 basis point (one basis point equals 1/100th of one percent)
hike in the Federal Funds rate. During the quarter, interest rates rose across
the maturity spectrum with intermediate rates increasing the most. The yield on
the thirty-year U.S. Treasury bond rose over 40 basis points in the first
quarter to 7.09% while rates on two- and five-year U.S. Treasury notes were up
over 50 basis points for the same period.
Higher rates meant lower prices for the Fund's securities with the prices of
longer-duration (a measure of a bond's price sensitivity to changes in interest
rates) bonds falling more than shorter ones. The Fund has a higher percentage
of bonds with long durations relative to the overall market, so the price
decline in the Fund was modestly greater than that in the LBAG. This price
decline was only partly offset by the income from the Fund's holdings, resulting
in a negative total return for the quarter.
Total Return: A Review
Given the difficult market environment of the past year, we thought that a
review of the sources of return for fixed income portfolios would be both
informative and timely. A fixed income investment has three sources of return:
the change in the price of the security over a given period, the coupon income
that the security provides, and the reinvestment of the bond's coupon. A bond's
price will change if there is a change in the overall level of interest rates,
or a change in the required yield that is specific to the bond or its issuer.
Since price changes can be positive or negative, the price change component can
increase or reduce a security's total return. Importantly, the income stream
provided by a bond is a full-time positive contributor to the total return of a
bond and, by extension, a bond fund.
As we have stated many times in the past, the price change of a bond fund can
overwhelm its income over shorter time periods. To use the most recent quarter
as an example: a fairly dramatic rise in interest rates (in this case around 50
basis points, or half of a percentage point) resulted in an average price
decline of approximately 2.5% on the Fund's holdings. The annual yield on the
Fund's securities at the beginning of this quarter was roughly 7%, equating to
quarterly income before management fees and expenses of about 1.75%. In this
case the 2.5% price decline was greater than the 1.75% income generated by the
Fund's securities, resulting in the negative total return for this quarter.
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Income Fund
Over longer time horizons, however, the income component of total return will
tend to be more important than the price change component. To continue the
above example, if this same interest rate rise (i.e., 50 basis points) occurred
over the space of an entire year, rather than three months, the Fund's annual
income of roughly 7% would more than offset the 2.5% price decrease and create a
modest positive total return. For longer periods, such as our three-to-five
year investment horizon, the income component of total return becomes even more
important as the effect of compounding (interest on interest) begins to play
out. It is important to note that this analysis assumes the reinvestment of
income. Of course, the Fund's actual returns will vary with changes in market
conditions.
Given the importance of income to the long-term total return of fixed income
securities, we focus much of our energy on building a relatively high and stable
yield for the Fund. To accomplish this we use our research and analytic
capabilities to identify securities, be they corporate, mortgage-backed, or
others, which will add to the yield of the Fund without incurring significant
risk of principal loss. An example of this opportunistic and deliberate search
for yield is the recent addition to the Fund of several "Trust-Preferred
Securities."
New Investment: Trust-Preferred Securities
The Fund's holdings of Trust-Preferreds are from three issuers: BankAmerica,
Citicorp, and J.P. Morgan. These securities have both fixed interest payment
schedules and maturity dates, and offer investors an attractive yield premium
relative to more traditional unsecured debt from the same issuers. This
additional yield is due primarily to the unique structure of these securities,
rather than credit-related risk. As such, we believe that the additional 25 to
40 basis points of yield that they offer over the straight debt of the same
issuers is more than adequate compensation for this structure.
In Closing
We will continue to emphasize the income component of total return by using our
research capabilities to build a stable, high quality portfolio with a higher-
than-market yield. 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
April 29, 1997 A. Horton Shapiro, President
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DODGE & COX
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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.
<TABLE>
<CAPTION>
Investment Performance Since Inception through March 31, 1997
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Comparison of change in value of a $10,000 investment in the Dodge & Cox
Income Fund and the LBAG Index
[LINE GRAPH APPEARS HERE]
Dodge & Cox LBAG
Income Fund INDEX
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<S> <C> <C>
01/01/89 10,000 10,000
12/31/89 11,411 11,455
12/31/90 12,256 12,482
12/31/91 14,451 14,479
12/31/92 15,581 15,550
12/31/93 17,350 17,067
12/31/94 16,848 16,568
12/31/95 20,252 19,630
12/31/96 20,988 20,339
03/31/97 20,825 20,226
</TABLE>
<TABLE>
<CAPTION>
Average annual total
return for periods ended 8.25 Years
March 31, 1997 1 Year 5 Years (Since Inception)
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<S> <C> <C> <C>
Dodge & Cox Income Fund 4.99% 7.93% 9.30%
Lehman Brothers Aggregate
Bond Index 4.91 7.19 8.47
</TABLE>
The chart covers the period from January 1, 1989 to March 31, 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 gains distributions.
The LBAG Index is a broad-based, unmanaged measure of U.S. dollar-denominated
investment grade rated securities, including U.S. Government, corporate, asset-
backed and mortgage-backed issues. 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 March 31, 1997
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<TABLE>
<CAPTION>
General Information
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<S> <C>
Net Asset Value Per Share $11.41
Total Net Assets (millions) $ 563
1996 Expense Ratio 0.50%
1996 Portfolio Turnover 37%
30 Day SEC Yield* 6.77%
Distributions to Shareholders
of Record 3/26/97 (per share): $0.18 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.
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<CAPTION>
Bond Characteristics
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<S> <C>
Number of Bonds 84
Average Quality AA+
Average Maturity 12.8 years
Effective Duration 5.21 years
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<TABLE>
<CAPTION>
Moody's/Standard & Poor's
Quality Ratings % of Fund
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<S> <C>
U.S. Government & Government Agencies 61.0
Aaa/AAA 4.3
Aa/AA 4.0
A/A 19.7
Baa/BBB 7.9
Ba/BB 0.4
Short Term Investments 2.7
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<CAPTION>
Asset Allocation
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[PIE GRAPH APPEARS HERE]
<S> <C>
Bonds: 97.3%
Short Term Investments: 2.7%
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<CAPTION>
Sector Breakdown % of Fund
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<S> <C>
U.S Treasury and Government Agency 20.0
Federal Agency CMOs and REMICs+ 20.6
Federal Agency Mortgage Pass-Through 20.4
Corporate 29.7
Foreign, U.S. Dollar-denominated 6.6
Short Term Investments 2.7
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+Collateralized Mortgage Obligation and
Real Estate Mortgage Investment Conduit
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<CAPTION>
Maturity Breakdown:
Years to Maturity % of Fund
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<S> <C>
0-1 years 2.9
1-5 38.9
5-10 25.2
10-15 6.8
15-20 3.9
20-25 7.3
25 and Over 15.0
</TABLE>
* 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 March 31, 1997
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<TABLE>
<CAPTION>
PERCENTAGE OF FUND
<S> <C>
BONDS: 97.3%
U.S. TREASURY & GOV'T. AGENCY: 20.0%
FEDERAL AGENCY CMOs & REMICs*: 20.6%
FEDERAL AGENCY MTG. PASS-THROUGH: 20.4%
CORPORATE: 29.7%
INDUSTRIAL: 15.7%
Lockheed Martin Corp., various securities ............... 2.7
Walt Disney Co. Debentures 7.55%, 2093, Callable 2023.... 2.5
Dayton-Hudson Corp., various securities ................. 2.4
May Department Stores, various securities ............... 2.2
General Motors Corp. Debentures 7.70%, 2016 ............. 1.6
Ford Motor Co. Debentures 9.95%, 2032 ................... 1.4
Time Warner Entertainment Sr. Debentures 8 3/8%, 2033 ... 1.4
Ford Holdings, Inc. Debentures 9 3/8%, 2020 ............. 1.0
Union Camp Corp. Debentures 9 1/4%, 2011 ................ 0.5
FINANCE: 12.2%
Norwest Corp., various securities ....................... 2.7
ITT Hartford Group, various securities .................. 2.1
General Electric Capital, various securities ............ 1.8
GMAC Put Notes 8 7/8%, 2010, Putable 2000/2005 .......... 1.6
BankAmerica Capital II, 8%, 2026, Callable 2006+ ........ 1.0
Citicorp Capital Trust, various securities+ ............. 1.0
J.P. Morgan Capital Trust I, 7.54%, 2027, Callable 2007+. 1.0
First Nationwide Bank Subordinated Debentures 10%, 2006.. 0.4
Barclays No. American Capital 9 3/4%, 2021, Callable 2001 0.3
CIGNA Corp. Notes 7.65%, 2023 ........................... 0.2
Banamex Export Funding Corp. 5.74%, 1997................. 0.1
TRANSPORTATION: 1.5%
Consolidated Rail Corp. Debentures 9 3/4%, 2020 ......... 1.2
Seaboard Coast Line Railroad Equipment 11 1/4%, 1999 .... 0.2
Norfolk & Western Railroad Equipment 10 1/8%, 2000 ...... 0.1
UTILITIES: 0.3%
Idaho Power Co. 1st Mtg. 9 1/2%, 2021, Callable 2001 .... 0.3
FOREIGN, U.S. DOLLAR-denominated: 6.6%
CANADIAN CORPORATE: 4.4%
Hydro-Quebec, various securities ........................ 3.0
Canadian Pacific Ltd. Debentures 9.45%, 2021 ............ 1.4
INTERNATIONAL AGENCY: 2.2%
Inter-American Dev. Bank 7 1/8%, 2023, Callable 2003 .... 1.4
European Investment Bank 10 1/8%, 2000 .................. 0.8
SHORT-TERM INVESTMENTS: 5.2%
OTHER ASSETS LESS LIABILITIES: (2.5%)
TOTAL NET ASSETS: 100.0%
</TABLE>
* Collateralized Mortgage Obligation and
Real Estate Mortgage Investment Conduit
+ Cumulative Preferred Securities
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
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Income Fund
General Information
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Investment Manager
Since 1930, Dodge & Cox has been providing professional investment management
for individuals, 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 Investment Plan
Shareholders may make regular monthly or quarterly investments of $100 or more
through automatic deductions from their bank accounts.
Withdrawal Plan
Shareholders owning $10,000 or more of the Fund's shares may 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 Plan
Shareholders may direct that dividend and capital gains distributions be
reinvested in additional Fund shares.
The above plans are completely voluntary and involve no service charge of any
kind.
IRA Plan
The Fund has available an Individual Retirement Plan (IRA) for shareholders of
the Fund.
Shareholder Inquiries
Fund literature and details on all of these Plans are available 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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