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D O D G E & C O X D O D G E & C O X
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Income Fund
Income Fund
Established 1989
Investment Managers -----------------
Dodge & Cox
One Sansome Street -----------------
35th Floor
San Francisco
California 94104-4405
(415) 981-1710
For Fund literature and
Information, please
write or call:
Dodge & Cox Funds
c/o BFDS
P.O. Box 9051
Boston
Massachusetts 02205-9051
(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 Quarterly Report
in the Fund unless it is March 31, 1998
accompanied by an effective
prospectus. 1998
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Printed on recycled paper.
3/98 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 1.41% for the quarter
ended March 31, 1998 compared to a total return of 1.54% for the Lehman Brothers
Aggregate Bond Index (LBAG), a broad-based index composed of investment grade
bonds. Average annual returns for longer time periods are summarized on page
three of this report.
Short and Intermediate Rates Fall in First Quarter
Short and intermediate rates for U.S. Treasury securities fell between 8 and 10
basis points in the first quarter (one basis point is equal to 1/100 of 1%). The
yield on the 30-year U.S. Treasury, after moving within a range of 5.7% to 6.1%,
finished the quarter almost unchanged at 5.9%. This small change in the yield
curve was motivated, in part, by continued signs of strong economic growth and
low inflation: the advance estimate for first quarter real GDP growth is 4.2%
while consumer prices were essentially unchanged. The modest drop in interest
rates resulted in slightly higher prices for the short and intermediate maturity
securities in the Fund.
The Fund's relative performance benefited from an overweight position in the
mortgage-backed security sector and a slightly higher yield. This positive
contribution was offset by an overweight position in corporate securities.
Mortgages outperformed both the government and corporate sectors for the
quarter, despite prepayment uncertainty in the lower interest rate environment.
The corporate sector suffered from slightly wider yield premiums amid continued
concern over the potential impact on U.S. corporations of the economic slowdown
in Asia.
A Discussion of Duration
At the beginning of the quarter, we lowered the duration of the Income Fund from
about 105% of the duration of the benchmark LBAG Index to roughly equal that of
the Index (4.35 versus 4.48 for the Index). Given this recent adjustment to the
portfolio, we think it is an appropriate time to discuss the duration decision
in greater detail and outline our rationale for a duration-neutral posture
versus the broad fixed-income market.
The duration of a fixed-income security (or portfolio of fixed-income
securities) measures the sensitivity of the secur ity's price to changes in the
general level of interest rates. The value, often stated in years, represents
the approximate percentage change in price if yields rise or fall by 1%. Thus,
for a given change in yields (either up or down), a longer duration security
will experience a greater change in market value than a shorter duration
security, all else being equal.
We determine the target duration of the Income Fund based on our assessment of
the probability of bonds producing attractive real rates of return (the return
after adjusting for inflation) over periods of three-to-five years. In making
this decision, we simulate the Fund's expected returns under a wide range of
interest rate and inflation scenarios. These simulations, together with our
outlook for inflation, illustrate the likelihood of fixed-income portfolios of
various durations producing positive real returns. The results of this analysis
form the basis for discussion among our investment professionals and are an
important input in determining an appropriate duration for the Fund.
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D o d g e & C o x
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Income Fund
With lower interest rates prevailing at the end of 1997 and certain economic
data pointing to a higher risk of accelerating inflation, our analyses suggested
a less positive outlook for real returns. This cautionary view stems from a
number of factors, including:
* Above-trend growth in the money supply. The M2 measure of the money
supply grew at a 5.6% annual rate in 1997 compared to a 3.8% increase in
real GDP.
* Sustained low levels of unemployment. At 4.7%, the average jobless rate
for the first quarter is the lowest since 1970.
* Signs of continued strong growth in the U.S. economy.
* Potential for a "wealth effect". Individuals feel wealthier as a result
of significant asset growth in the equity markets and respond by saving
less and spending more.
Given our tempered expectations for real returns, we adopted a duration-neutral
position in the Fund. That is, the price sensitivity of the Fund is now roughly
equal to or slightly less than that of the broad fixed-income market. The
adjustment was accomplished in January by trimming the Fund's holdings of longer
duration corporate bonds. We believe that this change will benefit the real
return prospects of the Fund over a three-to-five year investment horizon.
In Closing
While we feel that the duration decision is an important element of the fixed-
income management process, we will continue to emphasize the Dodge & Cox
hallmarks of fundamental research and individual security selection. Thank you
for your continued confidence in the Dodge & Cox Income Fund. As always, we
welcome your comments and questions.
For the Board of Trustees,
/s/ Harry R. Hagey /s/ A. Horton Shapiro
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Harry R. Hagey, Chairman A. Horton Shapiro, Executive Vice President
May 1, 1998
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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 investing 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, 1998
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[LINE GRAPH APPEARS HERE]
Dodge & Cox
Income Fund LBAG Index
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<S> <C> <C>
01/01/1989 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
12/31/1997 23,088 22,308
03/31/1998 23,414 22,653
</TABLE>
<TABLE>
<CAPTION>
Average annual total return for 9.25 years
periods ended March 31, 1998 1 Year 5 Years (Since Inception)
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<S> <C> <C> <C>
Dodge & Cox Income Fund 12.42% 7.48% 9.63%
Lehman Brothers Aggregate
Bond Index 12.00 6.94 9.24
</TABLE>
The chart covers the period from January 1, 1989 to March 31, 1998. 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-rated
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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D o d g e & C o x
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Income Fund
Fund Information March 31, 1998
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<TABLE>
<CAPTION>
General Information
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<S> <C>
Net Asset Value Per Share $12.03
Total Net Assets (millions) $780
1997 Expense Ratio 0.49%
1997 Portfolio Turnover 28%
30 Day SEC Yield* 5.99%
Fund Inception Date 1989
Investment Manager: Dodge & Cox,
San Francisco. Managed by
ten-member Bond Strategy Committee,
with members' average tenure at
Dodge & Cox of 12 years.
</TABLE>
<TABLE>
<CAPTION>
Asset Allocation
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<S> <C>
[PIE CHART APPEARS HERE]
Bonds: 95.1%
Short-Term Investments: 4.9%
</TABLE>
<TABLE>
<CAPTION>
Bond Characteristics
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<S> <C>
Number of Bonds 93
Average Quality AA+
Average Maturity 10.5 years
Effective Duration 4.35 years
</TABLE>
<TABLE>
<CAPTION>
Moody's/Standard & Poor's
Quality Ratings % of Fund
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<S> <C>
U.S. Government & Government Agencies 61.5
Aaa/AAA 2.7
Aa/AA 2.6
A/A 16.1
Baa/BBB 11.6
Ba/BB 0.6
Short-Term Investments 4.9
</TABLE>
<TABLE>
<CAPTION>
Sector Breakdown % of Fund
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<S> <C>
U.S. Treasury and Government Agency 22.6
Federal Agency CMO and REMIC+ 19.6
Federal Agency Mortgage Pass-Through 19.3
Asset-Backed 0.9
Corporate 27.4
Foreign (U.S. Dollar-denominated) 5.3
Short-Term Investments 4.9
+ Collateralized Mortgage
Obligation and Real Estate
Mortgage Investment Conduit
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<TABLE>
<CAPTION>
Maturity Breakdown % of Fund
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<S> <C>
0-1 Years to Maturity 15.6
1-5 38.2
5-10 20.6
10-15 4.8
15-20 2.4
20-25 7.7
25 and Over 10.7
</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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D o d g e & C o x
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Income Fund
<TABLE>
<CAPTION>
Portfolio of Investments March 31, 1998
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Percentage of Fund
<S> <C>
BONDS: 95.1%
U.S. TREASURY AND GOV'T AGENCY: 22.6%
FEDERAL AGENCY CMO* AND REMIC**: 19.6%
FEDERAL AGENCY MTG. PASS-THROUGH: 19.3%
ASSET-BACKED SECURITIES: 0.9%
CA Infrastructure and Econ. Dev. Bank SP Trust SCE-1
Rate Reduction Cft. 1997-1 A-2 6.14%, 3/25/2002.............. 0.9
CORPORATE: 27.4%
INDUSTRIAL: 13.8%
Raytheon Co., various securities............................... 2.9
Lockheed Martin Corp., various securities...................... 2.8
Dayton Hudson Corp., various securities........................ 2.6
Walt Disney Co. Debentures 7.55%, 7/15/2093.................... 2.1
May Department Stores, various securities...................... 1.8
Time Warner Entertainment Sr. Debentures 8.375%, 7/15/2033..... 1.2
Union Camp Corp. Debentures 9.25%, 2/1/2011.................... 0.4
FINANCE: 12.3%
Ford Motor Credit Co. Global Notes 7.20%, 6/15/2007............ 2.7
Norwest Corp., various securities.............................. 2.5
GMAC Put Notes 8.875%, 6/1/2010................................ 2.1
Hartford Financial Services Group, various securities.......... 1.6
J.P. Morgan Capital Trust I 7.54%, 1/15/2027................... 0.8
BankAmerica Capital II 8.00%, 12/15/2026....................... 0.8
Citicorp Capital Trust I 7.933%, 2/15/2027..................... 0.7
First Nationwide Bank Sub. Debentures 10.00%, 10/1/2006........ 0.6
Citicorp Capital Trust II 8.015%, 2/15/2027.................... 0.2
Barclays No. American Capital 9.75%, 5/15/2021................. 0.2
CIGNA Corp. 7.65%, 3/1/2023.................................... 0.1
TRANSPORTATION: 1.1%
Consolidated Rail Corp. 9.75%, 6/15/2020....................... 0.9
Seaboard Coast Line Railroad Equip. Tr. 11.25%, 3/1/1999....... 0.1
Norfolk & Western Railroad Equip. Tr. 10.125%, 7/1/2000........ 0.1
UTILITIES: 0.2%
Idaho Power Co. 1st Mtge. Bonds 9.50%, 1/1/2021................ 0.2
FOREIGN (U.S. DOLLAR-DENOMINATED): 5.3%
CANADIAN CORPORATE: 3.6%
Hydro-Quebec, various securities............................... 2.4
Canadian Pacific Ltd. 9.45%, 8/1/2021.......................... 1.2
INTERNATIONAL AGENCY: 1.7%
Inter-American Development Bank 7.125%, 3/15/2023.............. 1.1
European Investment Bank 10.125%, 10/1/2000.................... 0.6
SHORT-TERM INVESTMENTS: 3.5%
OTHER ASSETS LESS LIABILITIES: 1.4%
TOTAL NET ASSETS: 100.0%
</TABLE>
* CMO: Collateralized Mortgage Obligation
** REMIC: 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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D o d g e & C o x
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Income Fund
THIS PAGE INTENTIONALLY LEFT BLANK
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D o d g e & C o x
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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, 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 Shares of the Fund are purchased and redeemed at net asset
Fund 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 Plan of $100 or more through automatic deductions
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 Fund shares.
The above plans are completely voluntary and involve no service
charge of any kind.
IRA Plan The Fund has a Regular and Roth Individual Retirement Account
Plan (IRA) available for shareholders of the Fund.
Shareholder Fund literature and details on all of these Plans are
Inquiries available from the Fund upon request.
Dodge & Cox Income Fund
c/o BFDS
P.O. Box 9051
Boston, MA 02205-9051
(800) 621-3979
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