A disciplined, intrinsic-value-focused process and experienced team have led to an impressive track record at Gold-rated Diamond Hill Large Cap.
By Linda Abu Mushrefova | 11-11-17 | 10:48 PM | Email Article

The following is our latest Fund Analyst Report for Diamond Hill Large Cap . Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Linda Abu Mushrefova is a manager research analyst for Morningstar.

An experienced team led by veteran manager Chuck Bath with a commitment to their intrinsic value philosophy makes Diamond Hill Large Cap an excellent option for investors. Bath has been in charge since 2002 and is supported by two assistant managers, Chris Welch and Austin Hawley. The team is further bolstered by an impressive bench of analysts that are responsible for five to 15 names each, allowing them to conduct deep analysis. Together, they employ a proven approach that has rewarded investors over the long term. This fund earns a Morningstar Analyst Rating of Gold. 

The team follows a disciplined process predicated on their intrinsic value philosophy in which the team identifies names trading at a discount to their forecast intrinsic value. The performance dating back to Chuck Bath’s start has been excellent, besting its index and peers by more than 150 basis points on an annualized basis through October 2017. The performance is driven by the team’s bottom-up stock-picking process and disciplined sell process.

The team’s approach can result in distinctive sector over- or underweightings at times. For example, they have held a very large overweighting in the financials sector since 2012 and do not anticipate winding this down given that they are still finding value in the sector. Alternatively, the team currently holds an underweighting in technology citing a lack of opportunities based on their intrinsic value framework.

The contrarian approach can result in periods of underperformance. For example, the fund lagged its peers and index in the lead-up to the 2007-08 financial crisis. Despite their tendency to lag in speculative, momentum-driven markets, the team has proved it is worth sticking with given its success over a full market cycle.

An added benefit here is the fund’s attractive fees across all share classes. The disciplined process and experienced team have led to an impressive track record, something we expect to continue.

Process Pillar: Positive | Linda Abu Mushrefova 11/08/2017
Lead portfolio manager Chuck Bath takes the classic approach to value investing that marks all of Diamond Hill's investment offerings: He buys companies when their market prices are lower than his estimate of their intrinsic business value and sells them when they reach that value. Bath's successful execution of the process earns the fund a Positive Process rating. Turnover is below average, but he doesn't manage the fund with any specific turnover goal in mind, so trading may increase when volatility presents opportunities or strong markets inflate valuations and encourage selling. He employs a bottom-up process which can result in sector over- or underweightings at times depending on where opportunities are identified.

The fund doesn't adhere to any of the index's sector weightings, and cash can grow when markets become frothy. For this strategy, Bath generally invests in large- and mid-cap companies within the Russell 1000 Index. That index has companies with market caps as small as $1.4 billion, but this fund’s smallest holding by market cap is about $2.5 billion. Additionally, Bath’s process tends to result in a higher-quality bent, as evidenced by its below index average price/book and price/earnings ratios. Further, its return on invested capital is higher demonstrating the team’s commitment to its intrinsic value philosophy.

Chuck Bath and his team of analysts model names out five years and identify stocks that are trading at a discount to their forecast intrinsic value. The portfolio construction process follows a bottom-up, sector-agnostic approach. Their sell discipline is driven by the estimated intrinsic value. Once a stock reaches this level, the team will sell. Further, there is no strict level of margin of safety required for a name to enter the portfolio.

Bath and team have maintained an overweighting in the financials sector since 2012. Bath attributes this positioning to attractive valuations in the space, defined as discounts to tangible book value coupled with strong balance sheets. They continue to see a runway for their thesis and do not anticipate winding down the overweighting in the next couple of years barring any changes to the fundamentals.

As of October 2017, the portfolio contained more than 30% of assets in its top 10 names, and more than 20% of those have been held for at least five years. The team has advised that it has become more difficult recently to identify attractive new ideas. As the team is not comfortable sacrificing quality, turnover has been low as it prefers to hold on to its current names as long as they still trade at a discount. The fund’s cash position currently stands at about 2% but this could rise if the team is hard-pressed to identify attractive names.

Performance Pillar: Positive | Linda Abu Mushrefova 11/08/2017
Since Chuck Bath came aboard in 2002 through October 2017, the fund has an annualized return of 11.41% relative to its large-value Morningstar Category peers’ average of 8.23% and the Russell 1000 Index's 9.76% over the same time frame. The fund consistently lands atop its category on a risk-adjusted basis despite its slightly above-average risk profile. Bath’s continued success and ability to produce outsize outperformance for investors earn this fund a Positive Performance rating.

Since Bath took over in 2002, the fund has produced outperformance that has resulted in alpha in excess of 150 basis points relative to its Russell 1000 Index benchmark. Its success is attributable to impressive security selection as a result of its bottom-up approach. This fund will lag its peers in speculative environments because of its contrarian nature, but its disciplined process has rewarded investors over a full market cycle.

The fund’s process has proved itself over time but has had periods of underperformance. For example, in 2012 the fund lagged both its peers and its index owing primarily to an overweighting in energy and security selection within the sector. Despite such short periods, investors have been well-served here, and we expect this trend to continue.

People Pillar: Positive | Linda Abu Mushrefova 11/08/2017 
Chuck Bath took over this fund in 2002 upon joining Diamond Hill. He has backup from assistant managers Chris Welch (lead manager of  Diamond Hill Small-Mid Cap ) and Austin Hawley (lead manager for Diamond Hill All Cap Select ), who were named to the fund in 2009 and 2015, respectively. Assistant portfolio managers at Diamond Hill are expected to be familiar with those portfolios, though the ultimate responsibility lies with each strategy's lead portfolio manager. Bath previously worked with Welch and many of the firm's other portfolio managers at Nationwide Insurance, and he's been in the investment industry since 1982. The team’s stability and experience contribute to this fund’s Positive People rating.

Diamond Hill's portfolio managers draw upon a centralized research team of about two dozen sector-specialist analysts and associates who each cover about five to 15 names each in their respective areas. Those analysts average more than a decade of industry experience and well over half have received their CFA designation. In 2017, the team saw three departures including two analysts and one associate. Despite this uptick in personnel turnover, we still have confidence in the bench here.

Bath invests more than $1 million in this fund, while Welch invests $500,001-$1 million and Hawley $100,001-$500,000.

Parent Pillar: Positive | 04/10/2017
Previous CEO Ric Dillon remains with the firm as a portfolio manager and chair of this public company's corporate board. Chris Bingaman assumed the CEO role in January 2016, and he's been with the firm for more than 15 years. Diamond Hill takes additional steps to align its interests with fundholders'. For example, all employees must invest their personal wealth in Diamond Hill funds. And the fund board's compensation is also distributed in fund shares, where it must remain throughout directors' tenures. Plus, manager compensation emphasizes long-term performance instead of gathering assets. Indeed, the team has closed several strategies after they reached portfolio managers' capacity estimates.

Proven, tenured portfolio managers cultivate a strong investment culture. Chuck Bath, Chris Welch, and Bill Zox support Bingaman and guide the firm's prudent investment philosophy, rooted in an intrinsic-value based methodology. Rigorous due diligence underscores this approach, enabled by a team of about 40 portfolio managers and analysts. The team has expanded recently with 11 new additions between 2015 and 2016, including two experienced fixed-income managers. To capitalize on their expertise, the firm launched two new bond funds in 2016. Fund launches have been reasonable and consistent with the team's cautious approach to long-term investing.

Price Pillar: Positive | Linda Abu Mushrefova 11/08/2017
More than 60% of this fund’s assets are in its I share class, which charges a prospectus net expense ratio of 0.68%. This ranks below the peer group average of 0.77%. With a minimum investment of only $2,500, this share class is more easily accessible to investors relative to most institutional share class offerings. The rest of the share classes rank similarly relative to their respective peer groups, with the A and Y share classes ranking in the cheapest quartile and accounting for almost 40% of assets. The Y share class has a minimum investment of $500,000 and is not as easily accessible as its other offerings. Overall, this fund’s below-average fees earn it a Positive Price rating.

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Linda Abu Mushrefova does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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