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From Equity Research to International Investing With Heather Brilliant · Masters in Business

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Speaker 1: Bloomberg Audio Studios, Podcasts, radio News. This is Master's in
0:11
Speaker 1: Business with Barry rid Holds on Bloomberg Radio.
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Speaker 2: This week on the podcast, I have an extra special guest.
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Speaker 2: Heather Brilliant is CEO of Diamond Hill. They are a
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Speaker 2: publicly traded investment manager stock symbol DHIL that have been
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Speaker 2: public since day one since twenty sixteen. Heather comes for
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Speaker 2: with a fascinating background, having previously been in a number
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Speaker 2: of other places, most notably morning Star, and she has
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Speaker 2: a very specific approach to investment management and thinking about
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Speaker 2: stock selection. They do a number of things at Diamond
0:49
Speaker 2: Hill that many other investment shops don't. Not only are
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Speaker 2: they very much aligned with their investors, they regularly close
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Speaker 2: funds when they get too large, when they reach a
1:01
Speaker 2: capacity and run the risk of reducing performance. All of
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Speaker 2: their portfolio managers not only are substantial investors in each
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Speaker 2: of their funds, but they do a disclosure each year
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Speaker 2: that shows each manager by name and how much money
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Speaker 2: they have invested in their own fund. Kind of unique.
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Speaker 2: I wish more mutual funds and ETFs showed that data.
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Speaker 2: I found our conversation about her work and Diamond Hill
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Speaker 2: to be absolutely fascinating. They have a very unique approach.
1:34
Speaker 2: I think you'll find it fascinating. Also, with no further ado,
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Speaker 2: my discussion with Diamond Hills CEO, Heather Brilliant. Heather Brilliant,
1:44
Speaker 2: Welcome to Bloomberg.
1:46
Speaker 1: Thanks for having me Berry.
1:47
Speaker 2: Well, thanks for coming in. So let's start with your background.
1:50
Speaker 2: A bachelor's and economics from Northwestern and then an MBA
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Speaker 2: from University of Chicago. It sounds like the career plan
1:58
Speaker 2: was always financed. Was that the plan?
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Speaker 1: It was not the plan. I actually wanted to be
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Speaker 1: a lawyer, and so I started out as a political
2:04
Speaker 1: science major, and that really came from my experience on
2:09
Speaker 1: the debate team in high school and college. It was
2:11
Speaker 1: a big part of what influenced me. And I realized
2:14
Speaker 1: after undergrad actually that the skills you learned in debate
2:18
Speaker 1: can really be applied to picking stocks, where you really
2:21
Speaker 1: have to understand both sides of the story, but you
2:23
Speaker 1: still have to come down on one side and make
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Speaker 1: a decision. And so I felt like all of those
2:27
Speaker 1: experiences just really led me to love investing.
2:31
Speaker 2: Huh. Really interesting. So what was your first job out
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Speaker 2: of undergraduate?
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Speaker 1: I worked at Bank of America and they had a
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Speaker 1: wonderful corporate Finance training program. So since this was a
2:41
Speaker 1: relatively late decision that I came to, it was great
2:44
Speaker 1: to have those kind of six to eight weeks of
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Speaker 1: training before they set us loose.
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Speaker 2: And what led to the decision to get an MBA
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Speaker 2: at Chicago.
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Speaker 1: Well, actually I had pursued the CFA program first, and
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Speaker 1: I learned about the CFA from colleague of Bank of America,
3:01
Speaker 1: and I got right on it. As soon as I
3:03
Speaker 1: learned about it, I thought this is great and wished
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Speaker 1: i'd even known about it sooner. And then I had
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Speaker 1: a role at one point where they told me to
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Speaker 1: advance to the next level, I needed an MBA and
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Speaker 1: it was an investing role. So I said, why would
3:15
Speaker 1: I need that? I have a CFA and they said, sorry,
3:17
Speaker 1: rules are rules, and I never wanted to be told
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Speaker 1: that again. So I thought, I'll just get an MBA too.
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Speaker 2: And how did you find University of Chicago. There are
3:25
Speaker 2: some legendary professors there, Eugene Farma, Dick Thaylor, just really
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Speaker 2: an incredible line up.
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Speaker 1: There really are, And it was a very rigorous program
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Speaker 1: and I learned so much from classes that I never
3:38
Speaker 1: thought I would find exciting like marketing. You'd think that
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Speaker 1: marketing is pretty straightforward, but it turns out, you know,
3:45
Speaker 1: the University of Chicago figures out how to put a
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Speaker 1: quantitative lens on pretty much everything, and putting a quantitative
3:50
Speaker 1: lens on marketing back then, you know, twenty something years ago,
3:54
Speaker 1: was was pretty innovative, and I just thought it was
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Speaker 1: It was really a neat way to learn about it.
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Speaker 2: Right the old joke, half of our advertising dollars are wasted,
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Speaker 2: we just don't know which. Once you start doing things online,
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Speaker 2: that kind of changes.
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Speaker 1: You really contract that game exactly.
4:10
Speaker 2: So you've held analyst roles and a number of asset managers.
4:14
Speaker 2: You mentioned Bank of A, you were at dry House, Capital,
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Speaker 2: Cockhill Capital, morning Star. Tell us what you learned at
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Speaker 2: such very institutions.
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Speaker 1: I really learned how to appreciate investment philosophies and figure
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Speaker 1: out what my own personal investment philosophy was. My first
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Speaker 1: equity research job was Eddrie House and they're very aggressive
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Speaker 1: growth momentum oriented. But I was on the international team,
4:39
Speaker 1: and so the guy who was running the team at
4:41
Speaker 1: the time had a pretty fundamental approach, really looking for
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Speaker 1: more earnings momentum as opposed to price momentum, and I
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Speaker 1: just realized how he always veered towards higher quality companies,
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Speaker 1: and so I kind of leveraged that when I went
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Speaker 1: to morning Star, because they are very focused on quality,
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Speaker 1: the whole concept of economic modes, but also about buying
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Speaker 1: companies when they're trading at a discount to intrinsic value.
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Speaker 1: And it just seemed so much smarter to me to
5:06
Speaker 1: figure out ways to make sure that you're putting the
5:08
Speaker 1: risk reward in your favor.
5:10
Speaker 2: And you were a morning Star for about fourteen years,
5:14
Speaker 2: tell us what brought you there? What sort of work
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Speaker 2: were you doing?
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Speaker 1: So originally I went there because I liked their equity
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Speaker 1: research philosophy, and most people don't even know they do
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Speaker 1: equity research even to this day.
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Speaker 2: And you think morning Star, you immediately think of the
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Speaker 2: mutual fund Star system.
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Speaker 1: Yeah. Absolutely. But they had a whole team that was
5:31
Speaker 1: growing at the time because of the whole Spitzer settlement,
5:34
Speaker 1: and so they were hiring lots of people to come
5:36
Speaker 1: in and be be equity analysts, and so it was
5:38
Speaker 1: just a great opportunity to get to apply a more
5:40
Speaker 1: fundamental investment philosophy. And from there I really realized that
5:45
Speaker 1: While I loved being an investor or making investment recommendations,
5:49
Speaker 1: I also felt like it wasn't perhaps my true genius,
5:52
Speaker 1: and that I might be more successful in the long
5:54
Speaker 1: run to focus on a leadership direction of my career.
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Speaker 1: And so it was. I was actually only thirty when
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Speaker 1: I got the opportunity to run the equity research team
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Speaker 1: at morning Star. So it was just a really great
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Speaker 1: kind of early career opportunity to try out managing at scale.
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Speaker 2: Huh, very interesting. I specifically recall what I thought at
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Speaker 2: the time was a very bold and brave research report
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Speaker 2: that morning Star put out looking at the history of
6:21
Speaker 2: their Star rating system, and they pointed out, if you
6:26
Speaker 2: only could know one thing about a mutual funds, if
6:29
Speaker 2: you knew nothing but the cost, that would generate a
6:33
Speaker 2: little bit of positive return versus following any other system.
6:37
Speaker 2: And I give them a lot of credit for saying, yeah, yeah,
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Speaker 2: we built our business on the Star system, but hey,
6:43
Speaker 2: in a pinch, just look at what the expense ratios are.
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Speaker 1: It is fascinating how big a discrepancy that creates, because
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Speaker 1: you know, the expense is a sure thing and the
6:53
Speaker 1: expected future returns are very uncertain, And so I think
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Speaker 1: you have to take expense into consideration.
6:59
Speaker 2: So you become CEO of Morning Star. Am I pronouncing
7:04
Speaker 2: this right? Is it Australia or Australia Asia?
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Speaker 1: It was Australasia. But it's important to know that Australasia
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Speaker 1: really means Australia, New Zealand and the Pacific Islands. Oh,
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Speaker 1: it doesn't actually mean all of Asia.
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Speaker 2: I got it. So did you have to relocate were you?
7:18
Speaker 2: Were you working there?
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Speaker 1: I did? Yes, My family and I moved to Sydney, Australia.
7:22
Speaker 2: And what was that like? Sidney looks like it's a blast.
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Speaker 1: I consider Sydney one of the most majestically beautiful cities
7:27
Speaker 1: in the world. It was so wonderful every day we
7:31
Speaker 1: lived there, I felt.
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Speaker 2: Lucky and livable. Right, It's not like Hong Kong or
7:35
Speaker 2: New York or some other cities that can be a
7:38
Speaker 2: little much to take if you're not from there.
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Speaker 1: It's very livable from like a human interaction standpoint, yes,
7:45
Speaker 1: but it is very expensive. So I do think a
7:47
Speaker 1: lot of people struggle, especially you know when you see
7:50
Speaker 1: some cities that have suffered with very high housing costs.
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Speaker 1: Sydney is definitely right up there.
7:55
Speaker 2: Sure, so you're morning Star for a while, you leave
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Speaker 2: for a year and come back. Tell us what brought
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Speaker 2: you back to morning Star.
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Speaker 1: I left because I thought I was being offered my
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Speaker 1: dream job, and so I went to a hedge fund
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Speaker 1: for a year. I learned so much in that year
8:09
Speaker 1: I'll never regret doing it, and it was the only
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Speaker 1: time in my career where I've had responsibilities for recommending
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Speaker 1: shorts as well as lungs. So I think it was
8:18
Speaker 1: very eye opening from a lot of perspectives. But ultimately,
8:22
Speaker 1: I just really felt like the intensity of the role
8:25
Speaker 1: and expectations was not going to be tenable, and I
8:29
Speaker 1: was at the point in my life where I was
8:30
Speaker 1: ready to have a family, and so it just made
8:34
Speaker 1: more sense to stick with the philosophy I believed in,
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Speaker 1: but do it in an environment that I felt like
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Speaker 1: could give me a little bit more opportunity to have balance.
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Speaker 2: And then post morning Star, you end up in the
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Speaker 2: late twenty tens as CEO of First State Investments for
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Speaker 2: the Americas. Tell us a little bit about that role
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Speaker 2: and what you learned being CEO there.
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Speaker 1: Yeah, So, I mean, I love my time in Australia
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Speaker 1: and we were there almost four years and at the
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Speaker 1: end of that time, I really felt like as much
9:04
Speaker 1: as I had learned and experienced at morning Star, it
9:07
Speaker 1: was time to move on. And so I had a
9:09
Speaker 1: lot of contacts in Australia at that point, and one
9:12
Speaker 1: of them was the CEO of what was at the
9:14
Speaker 1: time called Colonial First State Global Asset Management, and so
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Speaker 1: First State Investments was the non Australia part of that business,
9:22
Speaker 1: and so they hired me to basically move to New
9:24
Speaker 1: York and run their business in the Americas, and in
9:28
Speaker 1: the process of doing that, the business, which had been
9:31
Speaker 1: owned by the Commonwealthank of Australia ended up being sold
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Speaker 1: to Mitsubishi UFJ. And so it was a really interesting
9:37
Speaker 1: time to kind of see through that whole process, and
9:39
Speaker 1: it's called First Centier now the business does still exist,
9:42
Speaker 1: but yeah, it was. It was a really interesting couple
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Speaker 1: of years.
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Speaker 2: And if I recall correctly, Mitsubishi Bank during the financial
9:49
Speaker 2: crisis was a financer of a couple of pretty substantial
9:53
Speaker 2: US banks, maybe Morgan Stanley, I don't remember, is that right,
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Speaker 2: And so tell us a little bit about what your
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Speaker 2: experience was like you were there before Mitsubishi brought them.
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Speaker 1: Correct My last day was the day the acquisition closed.
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Speaker 2: Oh, so would you helped facilitate this? What was your
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Speaker 2: role with that acquisition?
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Speaker 1: I mean the deal was definitely done in Japan and Australia,
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Speaker 1: not in the US. So I certainly had a lot
10:16
Speaker 1: of interaction with the team from Mitsubishi that was based
10:21
Speaker 1: in New York and kind of helping facilitate some of
10:24
Speaker 1: the transition that would that would be happening. But I
10:27
Speaker 1: had already taken the role with Diamond Hill, and so
10:30
Speaker 1: I helped them, you know, for a little bit of
10:31
Speaker 1: time to kind of navigate through the final aspects of
10:34
Speaker 1: the transition.
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Speaker 2: And I don't recall if this was on the podcast
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Speaker 2: with John Mack or in John Mack's book, but he
10:40
Speaker 2: had nothing but really nice things to say about Mitsubishi.
10:43
Speaker 2: I mean, they helped save Mooyants Stanley. He was certainly
10:47
Speaker 2: appreciative of that, but he seemed to think that there
10:50
Speaker 2: were no nonsense, They looked at the data, they made
10:53
Speaker 2: a fast decision in one way or another. He was
10:55
Speaker 2: pretty pleased with them. I'm assuming you had a similar experience.
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Speaker 1: Yeah, And I'd say one that's so great, And just
11:01
Speaker 1: to overgeneralize about Japanese bank owners is that they tend
11:05
Speaker 1: to be very long term oriented, and so they're making
11:08
Speaker 1: decisions about investing for the future and not just about
11:11
Speaker 1: you know, making quarterly earnings or any kind of short
11:13
Speaker 1: term pressure.
11:14
Speaker 2: So we'll talk about long term investing in a bit.
11:17
Speaker 2: Tell us what brought you from First State Investments to
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Speaker 2: Diamond Hill.
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Speaker 1: Given some of the transitions with First Date, I knew
11:25
Speaker 1: it it was time to maybe consider the next opportunity,
11:28
Speaker 1: and so I had actually interviewed for a couple of
11:30
Speaker 1: things when I got a call from a recruiter about
11:33
Speaker 1: Diamond Hill. I had actually never been to Columbus, Ohio
11:37
Speaker 1: before I went there to interview, and so when the
11:39
Speaker 1: recruiter called me, I said, you know, it sounds really interesting.
11:42
Speaker 1: I feel like the investment philosophy alignment is great. But
11:45
Speaker 1: I've never been to Columbus, so no, And so he said, well, wait, wait,
11:49
Speaker 1: they're coming to New York for the first round of interviews.
11:51
Speaker 1: I think you should just take the meeting. What's the downside?
11:55
Speaker 1: And so I was actually a little skeptical, but the
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Speaker 1: more I researched the company, the more compelled I was.
12:02
Speaker 1: I'm not only is the investment philosophy very aligned with
12:04
Speaker 1: the way I think about investing. But the team is incredible,
12:08
Speaker 1: and even from my first trip to Columbus, I realized
12:11
Speaker 1: what an amazing, liveable city it is, and it's a
12:15
Speaker 1: growing city, which is something not a lot of cities
12:18
Speaker 1: in the US can claim today. And so yeah, it
12:21
Speaker 1: ended up being I think a really good fit.
12:24
Speaker 2: So since you mentioned investing for the long run amongst
12:27
Speaker 2: the Japanese banks on the Diamond Hill Firm website, your
12:33
Speaker 2: tagline is invested in the long run. Shouldn't that be
12:37
Speaker 2: the Norman asset management? Aren't we all supposed to be
12:40
Speaker 2: invested in the long run?
12:42
Speaker 1: I think it absolutely should be the norm, because it
12:44
Speaker 1: is generally what our clients are seeking. And I think
12:48
Speaker 1: there's just so many pressures that cause so many investors
12:51
Speaker 1: to think shorter term, and even investors who claim to
12:54
Speaker 1: be long term are often thinking in one year increments
12:57
Speaker 1: as opposed to the more like five year increments that
12:59
Speaker 1: were trying to think about.
13:01
Speaker 2: So is that the fault of the end investor? Is
13:05
Speaker 2: it the institutions that really look at quarterly results? I
13:09
Speaker 2: know some hedge funds look at monthly or weekly results.
13:12
Speaker 2: That seems to be you know, nothing more than random noise,
13:15
Speaker 2: but they seem to focus on it. Who should we
13:20
Speaker 2: be blaming about this sort of short termism that can
13:24
Speaker 2: be endemic in the investing world.
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Speaker 1: I don't know if we can really blame any one party.
13:28
Speaker 1: I think it's kind of systemic at this point where
13:31
Speaker 1: you have companies reporting earnings on a quarterly basis, so
13:35
Speaker 1: many public companies expected to issue guidance and then meet
13:38
Speaker 1: that guidance or else, you know, essentially, And I think
13:42
Speaker 1: a lot of investors have figured out how to effectively
13:45
Speaker 1: make money for their clients with shorter term time horizons.
13:48
Speaker 1: Otherwise they wouldn't be doing it. And so I think
13:51
Speaker 1: there's enough forces out there that lead to people thinking
13:54
Speaker 1: that they can make money doing it. But I think
13:56
Speaker 1: there's more opportunity to take a longer time horizon or
14:00
Speaker 1: longer term perspective, because then you can really think about,
14:03
Speaker 1: you know, what are the earnings power, what is the
14:05
Speaker 1: long term earnings power of this business? And how can
14:08
Speaker 1: I think about myself as an owner of it in
14:10
Speaker 1: partnership with the management team, as opposed to to thinking
14:14
Speaker 1: about kind of where the stock price is going. Huh.
14:16
Speaker 2: So we kind of joke about the ill equidity premium,
14:20
Speaker 2: but really we should be talking about the long term
14:23
Speaker 2: premium that's being overlooked. Maybe there's a substantial market and
14:27
Speaker 2: efficiency there.
14:29
Speaker 1: I think there is, because you know, while I do
14:32
Speaker 1: think that clients like to invest for longer time periods,
14:34
Speaker 1: they only have so much patience and when you take
14:36
Speaker 1: a really long time prizon, you can have multi year
14:39
Speaker 1: periods of underperformance. And so that's not something that every
14:43
Speaker 1: client is willing to tolerate. And it's also very hard,
14:47
Speaker 1: I think every for all the parties involved to be
14:50
Speaker 1: able to consistently know, you know, is this underperformance because
14:54
Speaker 1: my investment manager is sticking to their philosophy or is
14:57
Speaker 1: it a deeper issue and I should be, you know,
14:59
Speaker 1: running for the hills. And so I think it's really
15:02
Speaker 1: really important to have a consistent philosophy and be able
15:05
Speaker 1: to show over you know, as much time as possible,
15:08
Speaker 1: ideally decades or more, that your ability to focus on
15:11
Speaker 1: a long time horizon really does come back around and
15:14
Speaker 1: generate out performance for your clients in the long term.
15:17
Speaker 2: Really really interesting. So let's talk a little bit about
15:20
Speaker 2: Diamond Hill stock symbol DHIL. What's it like running a
15:26
Speaker 2: public company. They've been public since nineteen ninety six, So.
15:30
Speaker 1: Yes, it has been a public company really since the
15:32
Speaker 1: founding because essentially there was an already public business that
15:36
Speaker 1: the founder of Diamond Hill kind of merged into or
15:39
Speaker 1: used as the beginning of Diamond Hill. So there was
15:42
Speaker 1: never a moment where the company went public. It's really
15:46
Speaker 1: just been a factoid of the whole history of it.
15:48
Speaker 2: It's been publics from day one. Yes, huh. So earlier
15:52
Speaker 2: we were talking about investing for the long haul. What
15:55
Speaker 2: sort of challenges are there when shareholders are looking for
16:00
Speaker 2: a quarterly results that looking for revenues and improvements and profits.
16:04
Speaker 2: How do you get people to focus on the long
16:06
Speaker 2: term when every three months there's a snapshot of here's
16:11
Speaker 2: where we are in the cycle.
16:13
Speaker 1: There's nothing we can do to avoid the fact that
16:15
Speaker 1: we need to publish our results every quarter. But there
16:18
Speaker 1: are actually things that a lot of public companies do
16:20
Speaker 1: that are not a requirement. For example, quarterly earnings calls
16:23
Speaker 1: and guidance, and so those are things that we don't
16:26
Speaker 1: participate in because.
16:27
Speaker 2: No guidance, no quarterly call. Correct, just you release the
16:31
Speaker 2: numbers and let the chips full where they may exactly.
16:34
Speaker 1: And the reason why that's so important is because we
16:37
Speaker 1: don't want to on a quarterly basis be essentially pressured
16:41
Speaker 1: into focus on a shorter time period by people asking
16:44
Speaker 1: questions about a shorter time period. And we do think
16:46
Speaker 1: that the short time periods are noise. And so what
16:49
Speaker 1: we do instead is we hold a shareholder meeting or
16:52
Speaker 1: a management presentation for shareholders once a year, where we do,
16:55
Speaker 1: you know, kind of take a step back and look
16:57
Speaker 1: at the year and review our expectations going forward and
17:00
Speaker 1: really try to lay out the strategy and how we
17:03
Speaker 1: are evolving in this ever changing market.
17:07
Speaker 2: Diamond Hill has always been public from day one. The
17:11
Speaker 2: founder sort of reverse merged the company into an existing
17:16
Speaker 2: public entity. Does that mean the float isn't giant that
17:20
Speaker 2: a lot of the lot of the holdings are held
17:23
Speaker 2: by founders. How much of the stock publicly trades.
17:27
Speaker 1: It's actually pretty pretty big. It's about eighty percent, so
17:31
Speaker 1: it is just under twenty percent owned by management and directors.
17:35
Speaker 1: I think actually, if you go public, there tends to
17:37
Speaker 1: be a more of a concentration in owners holding founder
17:41
Speaker 1: stock exactly. But when the situation is more like using
17:45
Speaker 1: stock to fund the beginning years of the company. I
17:47
Speaker 1: think it ends up leading to a more diverse shareholder okase.
17:50
Speaker 2: And you mentioned founders and managers. What about employees. Do
17:54
Speaker 2: they have the opportunity to participate in an ESOP or
17:58
Speaker 2: anything like that.
17:59
Speaker 1: We have a a very strong commitment to an ownership mentality,
18:02
Speaker 1: and we think that owning a piece of the company
18:05
Speaker 1: is part of that. It's really just a small part
18:07
Speaker 1: of it in the grand scheme of things. It's more
18:09
Speaker 1: about thinking like an owner when we're making every day decisions.
18:12
Speaker 1: But we do reinforce that by providing a grant of
18:15
Speaker 1: shares that vest in five years for every employee when
18:19
Speaker 1: they start, and then we have programs to allow for
18:22
Speaker 1: employees to purchase shares at a discount and also to
18:25
Speaker 1: be able to participate for certain roles in a long
18:28
Speaker 1: term incentive program.
18:30
Speaker 2: You mentioned ownership mentality. As I was clicking around your website,
18:34
Speaker 2: I found a fascinating document that shows each of your
18:39
Speaker 2: portfolio managers by name, the funds they manage and how
18:45
Speaker 2: much of their own dollars are invested in their own
18:49
Speaker 2: managed funds. And very often these are seven figures or
18:53
Speaker 2: more millions of dollars invested in their own funds tell
18:56
Speaker 2: us a little bit about that.
18:58
Speaker 1: I'm so glad you brought that up, because I do
18:59
Speaker 1: think it's a really big differentiator for us. We have
19:03
Speaker 1: really focused on the fact that if we're invested alongside
19:06
Speaker 1: our clients, we're making decisions for them that will be
19:10
Speaker 1: in our best interest and their best interests. So we
19:12
Speaker 1: really think that it creates alignment to have our portfolio
19:15
Speaker 1: managers meaningfully owning shares of the funds that they manage. Now,
19:20
Speaker 1: of course that is completely up to them, but when
19:22
Speaker 1: we're hiring people or promoting people, we really do make
19:26
Speaker 1: sure that it's clear that this is something that we
19:28
Speaker 1: think is a differentiator for us. And I'd say part
19:32
Speaker 1: of it is reinforced by the fact that we do
19:34
Speaker 1: have policies that prohibit our employees from investing in individual
19:37
Speaker 1: securities because we want their time to be devoted to
19:40
Speaker 1: making the right decisions for our clients and they can
19:43
Speaker 1: benefit from that as a client. And so I think
19:46
Speaker 1: that's really just led to a culture where we really
19:49
Speaker 1: all feel like we're there for the benefit of our clients.
19:52
Speaker 2: What's a better advertisement for a mutual fund than the
19:55
Speaker 2: fund manager having millions and millions of dollars invested in
19:58
Speaker 2: that exact fund.
19:59
Speaker 1: Absolutely.
20:00
Speaker 2: So there's another line on your website that kind of
20:03
Speaker 2: quote my attention, our curiosity uncovers unique opportunities. Tell us
20:09
Speaker 2: a little bit about that.
20:11
Speaker 1: So on the equity side in particular, a lot of
20:13
Speaker 1: what we do really is to do very deep fundamental
20:17
Speaker 1: research on companies from a bottom up perspective, and so
20:21
Speaker 1: we're constantly looking for new ideas and opportunities to put
20:24
Speaker 1: in the portfolios. But despite that constant curiosity, our portfolios
20:29
Speaker 1: do not have very high turnover because we are taking
20:31
Speaker 1: such a long term perspective. So we're looking for businesses
20:34
Speaker 1: that are fundamentally mispriced relative to what we think, you know,
20:38
Speaker 1: a normalized earnings environment would result in. And sometimes that's
20:41
Speaker 1: caused by dislocations for the business that we think will reverse.
20:45
Speaker 1: Sometimes it's you know, growth potential in the future that
20:47
Speaker 1: we don't think is priced in. But there's always got
20:50
Speaker 1: to be some element of the valuation really being compelling.
20:54
Speaker 1: And I think, you know, if you're really looking at
20:56
Speaker 1: the intrinsic value of a company and estimating the cash
20:59
Speaker 1: flows the business canerate and looking for opportunities where the
21:02
Speaker 1: stocks are mispriced relative to that you have to take
21:05
Speaker 1: a long term perspective.
21:06
Speaker 2: I'm hearing a couple of things that I want to
21:08
Speaker 2: ask some follow up questions. So bottoms up stock selection
21:11
Speaker 2: pretty obvious. It's not that you're doing sector rotation or
21:15
Speaker 2: market timing. You're purchasing specific companies. But then the added
21:20
Speaker 2: layer is you're purchasing them at a discount to intrinsic value.
21:26
Speaker 2: So this sounds a lot like traditional value investing, which
21:30
Speaker 2: has had a rough couple of years. How do you
21:33
Speaker 2: differentiate yourself from traditional value investors?
21:38
Speaker 1: I mean, I think there's a lot of what we
21:39
Speaker 1: do that I would say is not too far from
21:41
Speaker 1: being traditional value investor. I'd say both for Diamond Hill
21:45
Speaker 1: as for a lot of investors. There's kind of an
21:47
Speaker 1: ideal out there where you want to buy a company
21:50
Speaker 1: that has a strong competitive advantage training at a discount
21:52
Speaker 1: to what you think those future cash flows are worth.
21:55
Speaker 1: That is kind of the fundamental perfect investment opportunity for
21:58
Speaker 1: almost any investment philosophy. And I think the difference between
22:01
Speaker 1: you know, a traditional value investor versus you know, we
22:03
Speaker 1: kind of call ourselves intrinsic value investors versus someone who
22:07
Speaker 1: calls themselves. A growth investor is just really, you know,
22:10
Speaker 1: what do you prioritize when you don't have that ideal situation.
22:14
Speaker 1: So for us, you know, we'd still rather buy a
22:16
Speaker 1: higher quality business trading at a small discount than a
22:19
Speaker 1: low quality business trading at a big discount. But fundamentally,
22:22
Speaker 1: I'd say it just it really requires you to understand,
22:26
Speaker 1: you know, what is the competitive position of this business
22:29
Speaker 1: and how predictable are those future cash flows.
22:32
Speaker 2: When I hear competitive position, I immediately think of the
22:35
Speaker 2: morning star mote you described earlier. Tell us how that
22:39
Speaker 2: works into your investing philosophy.
22:42
Speaker 1: It was interesting coming to Diamond Hill. I think one
22:44
Speaker 1: of the reasons why the portfolio managers were comfortable hiring me,
22:49
Speaker 1: as you know, the first external CEO that they had
22:51
Speaker 1: ever had, is because I had very widely talked about
22:55
Speaker 1: economic modes and investing with an eye on sustainable competitive advantage.
23:00
Speaker 1: But even in the book I wrote in twenty fourteen,
23:02
Speaker 1: you could see that the focus on competitive advantage can
23:05
Speaker 1: never be absolute. You always have to take valuation into consideration.
23:11
Speaker 1: I would say in general, we probably put a little
23:14
Speaker 1: bit more bias towards valuation as the primary consideration and
23:18
Speaker 1: competitive advantage as very important, but maybe second to valuation
23:22
Speaker 1: as a primary consideration.
23:24
Speaker 2: So valuation, high quality, competitive advantage. Are we leaving out
23:29
Speaker 2: any other specifics that are go into the investing stock
23:33
Speaker 2: selection process?
23:35
Speaker 1: I mean very concentrated portfolios and a long term perspective.
23:40
Speaker 2: So I love when I hear concentrated portfolio because I
23:43
Speaker 2: immediately think high active share, no closet indexing, exactly. So
23:48
Speaker 2: when you say concentrated, how concentrated is concentrated?
23:52
Speaker 1: So our large cap strategy has about fifty positions in it.
23:55
Speaker 2: That's pretty concentrated, exactly.
23:57
Speaker 1: So I think that gives you an example. You know, well,
24:00
Speaker 1: small cap is more than that, but it's still less
24:02
Speaker 1: than one hundred.
24:02
Speaker 2: Small cap is always more than large cap. We're going
24:06
Speaker 2: to talk a little bit about small cap later, which
24:09
Speaker 2: has been kind of fascinating what's been going on in
24:11
Speaker 2: that space lagging for as long as it has. But
24:15
Speaker 2: before I get to that, I want to talk about
24:18
Speaker 2: not only how you express the philosophy in investments, but
24:23
Speaker 2: the different strategies you run in equity and fixed income.
24:27
Speaker 2: I know you do separately managed accounts, you do mutual funds,
24:31
Speaker 2: and you also do a C explain those choices.
24:36
Speaker 1: So essentially, we try to offer our intellectual property to
24:40
Speaker 1: our clients in whatever vehicle that they need it to
24:43
Speaker 1: be in. You know, we started out kind of focused
24:45
Speaker 1: on mutual funds as the vehicle, and we've really diversified
24:49
Speaker 1: away from that because of client interest. Clients have asked
24:52
Speaker 1: us for separate accounts model delivery CIS and we have
24:55
Speaker 1: happily obliged. Now, i'd say the big topic you know
24:59
Speaker 1: on the table is e The challenge with ETFs is
25:02
Speaker 1: that you cannot constrain capacity, and we believe very strongly
25:06
Speaker 1: that in order to make sure that we can always
25:09
Speaker 1: deliver for our existing clients, we have to be able
25:11
Speaker 1: to constrain to close strategies, to.
25:13
Speaker 2: Be able to say no and close a fund down,
25:15
Speaker 2: not just fire hose of capital.
25:18
Speaker 1: Coming up exactly. And as many very popular ETFs show,
25:22
Speaker 1: and as you know, just as fundamentally true, you cannot
25:25
Speaker 1: close an ETF today, and so in order to take
25:28
Speaker 1: capital in an ETF, we have to figure out some
25:30
Speaker 1: kind of solution to that, and we have not figured
25:32
Speaker 1: out a solution.
25:33
Speaker 2: That's really interesting. So I know you're running about twenty
25:37
Speaker 2: nine billion total. How big is the biggest fund where
25:41
Speaker 2: you say, okay, we're we're pretty close to capacity here.
25:44
Speaker 1: So our large cap strategy was closed to new investors
25:47
Speaker 1: until about a year ago. And so over the course
25:50
Speaker 1: of history, we've closed for strategies over time. And you know, generally,
25:55
Speaker 1: i'd say we take a lot of things into consideration.
25:58
Speaker 1: Our clients actually like to be able to put new
26:01
Speaker 1: clients of theirs into the same strategies, and so it
26:03
Speaker 1: can be very disruptive for client bases for you to
26:06
Speaker 1: just abruptly and suddenly close strategies. So it generally is
26:09
Speaker 1: something that we plan as we see it coming and
26:12
Speaker 1: really try to collaborate with our clients so that we
26:15
Speaker 1: can appreciate where it may create a challenge for no reason.
26:19
Speaker 1: But in general, yeah, we've closed at times. We've had
26:22
Speaker 1: small cap SMID and large cap SMID. Yeah.
26:27
Speaker 2: By the way, a little industry jargon. I always laugh
26:29
Speaker 2: when I say that. We listen, we laughed since the
26:32
Speaker 2: jargon all the time. So small and mid cap, yes,
26:35
Speaker 2: So I would imagine the large cap has bigger capacity
26:39
Speaker 2: eight ten, twelve billion. Where do you start to run
26:42
Speaker 2: into Hey, for fifty stocks, this is as big as
26:45
Speaker 2: we want to get.
26:45
Speaker 1: Yeah, I mean, we think the capacity for that is
26:48
Speaker 1: somewhere around twenty five or thirty billion.
26:50
Speaker 2: Oh so you haven't really run into issues with that yet.
26:52
Speaker 1: Yeah, I mean I would say that's for the strategy overall.
26:56
Speaker 1: You know, So it partially depends on how much is
26:59
Speaker 1: in the fund versus in you know, other areas.
27:02
Speaker 2: But in a small cap or a SMID you can
27:04
Speaker 2: say to your investing partners, hey, we're getting to the
27:09
Speaker 2: point where we're just about capacity constrained. Don't be surprised
27:13
Speaker 2: if this closes next quarter, next year. How far out
27:16
Speaker 2: do you plan it?
27:17
Speaker 1: I mean generally, if it's flows related, it's easier to plan.
27:20
Speaker 1: If it's market related, it's harder, because you know, if
27:23
Speaker 1: all of a sudden, small caps make it come back,
27:25
Speaker 1: you know, when you didn't think you were anywhere to
27:26
Speaker 1: close to closing, it can come up more quickly. With
27:29
Speaker 1: large cap I'd say it also depends on how low
27:32
Speaker 1: you go in terms of market cap, right, how small
27:35
Speaker 1: a company will you put into a strategy that is
27:37
Speaker 1: considered large cap. So for us, i'd say that is
27:40
Speaker 1: a big swing factor that constantly get gets debated, And
27:43
Speaker 1: what we always try to do is look at the
27:45
Speaker 1: actual history where we actually invested clients capital, because that
27:49
Speaker 1: is what has created our track record and that we
27:51
Speaker 1: need that in order for it to be you know,
27:53
Speaker 1: repeatable in the future.
27:54
Speaker 2: Huh, that's really interesting. So what do you use as
27:57
Speaker 2: a benchmark for the large cap fund? Is it just
28:00
Speaker 2: the SMP five hundred or something a little broader.
28:03
Speaker 1: We use the Rustle at one thousand, so much broader.
28:06
Speaker 2: Yeah, I was going to say, if you want to
28:08
Speaker 2: just arbitrarily draw a line in the sand the top
28:12
Speaker 2: half of the SMP five hundred, I would imagine those
28:16
Speaker 2: two hundred and fifty stocks can be considered large cap,
28:19
Speaker 2: or like, what's the line in the sand above ten billion,
28:23
Speaker 2: above twenty five billion? It's hard to even judge when
28:26
Speaker 2: we have so many companies that are trillion dollar market
28:29
Speaker 2: caps these days.
28:30
Speaker 1: Well, that actually brings up a really interesting point in time,
28:33
Speaker 1: I'd say, with our markets being so driven by such
28:36
Speaker 1: a small number of stocks, and we generally think that
28:39
Speaker 1: creates opportunity not only in the large cap space, but
28:41
Speaker 1: really across the cap spectrum. But you know, even in
28:45
Speaker 1: the first half of twenty twenty four, more than sixty
28:48
Speaker 1: percent of the return came from six companies, And so
28:51
Speaker 1: I do think we're getting to the point where what
28:53
Speaker 1: you see going on under the surface is so different
28:56
Speaker 1: from what the overall you know, quote unquote market return
28:58
Speaker 1: looks like these days.
28:59
Speaker 2: You know, I'm so glad you said that. Every time
29:02
Speaker 2: I have a discussion about passive or indexing with people
29:06
Speaker 2: who are convinced that's gonna destroy the structure of the market,
29:11
Speaker 2: my answer is always, wouldn't that create more inefficiencies elsewhere
29:16
Speaker 2: in the market if all these flows are blindly going
29:19
Speaker 2: into passive And there's certainly a reason for that, but
29:23
Speaker 2: tell us about how that leads to inefficiencies that savvy
29:28
Speaker 2: investors can take advantage of.
29:30
Speaker 1: Yeah, I think you can see this particularly in smaller
29:33
Speaker 1: cab companies right now, where you know, as you alluded
29:36
Speaker 1: to earlier, the Russell two thousand versus the Russell one
29:39
Speaker 1: thousand has basically underperformed by ninety five percent from the
29:43
Speaker 1: end of twenty sixteen until now.
29:45
Speaker 2: That's amazing, it's stunning.
29:46
Speaker 1: And you know, it's true that smaller cab companies are
29:50
Speaker 1: much more challenging because you know, forty ish percent of
29:53
Speaker 1: small cap companies don't make a profit, and so there are.
29:56
Speaker 2: I think where it's seven percent of large of the
29:58
Speaker 2: s and P five hundred is not profitable, which is
30:02
Speaker 2: a fraction of what it was in the late nineties.
30:05
Speaker 2: Much more of the big caps weren't profitable. Today they're
30:08
Speaker 2: all money machines. The small caps really are kind of
30:11
Speaker 2: struggling against that.
30:13
Speaker 1: And the interesting thing is that small cap active managers
30:17
Speaker 1: have outperformed for out of three out of the last
30:20
Speaker 1: four years. But in small cap about sixty percent of
30:23
Speaker 1: assets are invested passively. It's actually only fifty percent in
30:27
Speaker 1: large cap. So it's kind of surprising that investors are
30:30
Speaker 1: relying on passive strategies in a category where active management
30:34
Speaker 1: makes a huge difference.
30:35
Speaker 2: So let me make sure I'm hearing that correctly. Sixty
30:39
Speaker 2: percent of small cap is indexed versus fifty percent in
30:44
Speaker 2: large cap, and more small cap managers are beating their
30:48
Speaker 2: benchmark than large cap managers? Am I getting that right exactly?
30:52
Speaker 2: So that kind of goes back to, hey, the more
30:54
Speaker 2: indexing there is, the more opportunities there are for inefficiencies
30:58
Speaker 2: to be discovered.
30:59
Speaker 1: Yes, but let's say that one element of reality I
31:03
Speaker 1: think that has for managers who are focused on smaller
31:05
Speaker 1: cap companies is that you can't buy an undervalued company
31:09
Speaker 1: in small cap necessarily and assume that it's going to
31:12
Speaker 1: appreciate because of valuation, because we don't know when or
31:17
Speaker 1: what will cause the market to rerate small cap. And
31:19
Speaker 1: so you know, this has been going on for you know,
31:22
Speaker 1: basically a decade or more depending on how you look
31:24
Speaker 1: at the data. So I think given that, what we
31:27
Speaker 1: see is our analysts and portfolio managers increasingly focusing on
31:31
Speaker 1: investing in small caps that are high quality businesses generating
31:36
Speaker 1: cash flow, returning that cash flow to shareholders, where essentially
31:39
Speaker 1: the cash return is going to get you what you
31:41
Speaker 1: need as an investor, and you don't need the valuation
31:43
Speaker 1: to rerate. If it does, it'll be bonus.
31:46
Speaker 2: That's dividends and buybacks in terms of you know, David
31:49
Speaker 2: Einhorn said something very similar when people were saying the
31:53
Speaker 2: market structure was broken by passive and I know he's
31:56
Speaker 2: in that camp. He said, it made us re think
32:00
Speaker 2: our approach to valuation and if merely buying inexpensive stocks
32:05
Speaker 2: wasn't going to get you the performance you need, well,
32:07
Speaker 2: then you had to find the stocks that were doing
32:09
Speaker 2: something to raise their evaluation themselves. Mostly through return of
32:13
Speaker 2: capital to investors.
32:15
Speaker 1: Yeah, that was a great episode. I think Einhornhet had
32:17
Speaker 1: a lot of really good points that I think we're.
32:19
Speaker 2: So you agree with him. It's hey, we like these
32:22
Speaker 2: stocks that are actually participating and there are opportunities being
32:26
Speaker 2: created by the rise of passive. So let me ask
32:30
Speaker 2: one other question about the rise of indexing. It has
32:34
Speaker 2: helped to contribute to fees coming down across the industry.
32:39
Speaker 2: You're a public company, how do you deal with those
32:42
Speaker 2: fee pressures that seem to be endemic throughout all of investing.
32:47
Speaker 1: I mean from the beginning, we really try to take
32:49
Speaker 1: a very thoughtful approach to setting our fees, and you know,
32:52
Speaker 1: we really try to think about, you know, what do
32:54
Speaker 1: we believe the excess return is that we can generate
32:56
Speaker 1: over the long run, and how can we charge a
33:00
Speaker 1: price for that so that we can make sure we
33:02
Speaker 1: can pay the you know, investment talent that we need
33:05
Speaker 1: in order to generate those returns, but also make sure
33:08
Speaker 1: that the shareholders of the firm are getting you know,
33:10
Speaker 1: paid back for the capital they provide, and ultimately that
33:13
Speaker 1: the clients are getting a return after fees that makes
33:16
Speaker 1: sense for them. And so that kind of third to third.
33:18
Speaker 1: A third mentality has led us to to set fees
33:22
Speaker 1: at a place that you know generally do not exceed
33:24
Speaker 1: the median of kind of morning star categories for fees,
33:28
Speaker 1: and we look at that too, because we really want
33:31
Speaker 1: to make sure that we are not charging more than
33:34
Speaker 1: we think is the value we can generate fair enough.
33:37
Speaker 2: So we were talking earlier about small caps. They've been
33:41
Speaker 2: lagging not just since the pandemic but pretty much the
33:45
Speaker 2: past decade. What do you think the reason for that is?
33:48
Speaker 2: Is it access to capital or into national markets? What's
33:51
Speaker 2: been holding small caps back?
33:55
Speaker 1: I actually think there's a couple of things, but the
33:57
Speaker 1: biggest is that small caps have not done so poorly
34:02
Speaker 1: as much as large caps have just done so excellently.
34:05
Speaker 1: And so I think that's partially these five stocks really
34:08
Speaker 1: driving the market that we're really seeing come to a
34:11
Speaker 1: head this year, but really has been going on for
34:13
Speaker 1: the last several years, and we've seen concentration in the
34:16
Speaker 1: large cap side of the market among those five companies
34:19
Speaker 1: getting greater and greater over that time period. So it's
34:23
Speaker 1: just very hard for any kind of diversified portfolio to
34:26
Speaker 1: keep up with that. And you can see that in
34:28
Speaker 1: a diversified large cap portfolio and any kind of actively
34:32
Speaker 1: managed large cap portfolio relative to indexes. And you can
34:35
Speaker 1: certainly see it in small caps as well.
34:37
Speaker 2: Right. I have a friend who's a trader who says, hey,
34:40
Speaker 2: you can't eat relative performance, right exactly. So we talked
34:45
Speaker 2: a little bit earlier about profitability. Ninety three percent of
34:48
Speaker 2: big caps are profitable, but only a little more than
34:51
Speaker 2: half of small cap stocks are profitable. How important are
34:56
Speaker 2: earnings to the small cap sector as a driver of returns.
35:02
Speaker 1: I mean, I think quarterly earnings probably should be less
35:04
Speaker 1: of a driver for small caps because you know, you
35:07
Speaker 1: have to take a long term perspective and really think
35:09
Speaker 1: about when they might become profitable. And I think also
35:12
Speaker 1: small caps tend to have more issues with debt, so
35:15
Speaker 1: it's really important for small cap investors to be very
35:18
Speaker 1: aware of the leverage that the companies are carrying, and
35:22
Speaker 1: I think in this environment too, to really understand the
35:24
Speaker 1: interest rate that that leverage carries and the potential interest
35:28
Speaker 1: rate that they may face when needing to refinance that debt.
35:31
Speaker 2: And it seemed like the large cap in megacap stocks
35:35
Speaker 2: did a great job in refinancing before the pandemic, small
35:39
Speaker 2: caps did not have access to the same amounts of
35:43
Speaker 2: capital at the same price as How big of a
35:46
Speaker 2: factor is that.
35:47
Speaker 1: I think it's a huge factor. And you know, and
35:49
Speaker 1: you also see less leverage, you know, certainly as a
35:53
Speaker 1: proportion of cash flows when you're looking at large caps
35:56
Speaker 1: versus small caps, so they're more levered and they did
35:59
Speaker 1: not have the same access to benefit from all that
36:01
Speaker 1: cheap capital when it was available.
36:03
Speaker 2: Diamond Hill is known mostly as a stock shop, as
36:06
Speaker 2: an equity shop bottoms up stock selection, but you also
36:11
Speaker 2: do fixed income and bonds. Tell us a little bit
36:13
Speaker 2: about the fixed income side of the work.
36:16
Speaker 1: Yeah, so about four billion of our assets under management
36:19
Speaker 1: are in fixed income strategies today and that's really grown
36:23
Speaker 1: over the last couple of years because we brought in
36:26
Speaker 1: a team in twenty sixteen have been building a track
36:29
Speaker 1: record since then, primarily in two strategies, core and short
36:34
Speaker 1: duration securitized, and in both of those strategies are I
36:37
Speaker 1: would say our biggest point of differentiation is our focus
36:39
Speaker 1: on securitized assets, which kind of gives us the opportunity
36:43
Speaker 1: to be able to make investments in areas that I
36:46
Speaker 1: think other bond managers either don't know as deeply or
36:50
Speaker 1: are more focused on macro trends where we take a
36:53
Speaker 1: bottom up approach there too. So it's really given us,
36:56
Speaker 1: I think, the opportunity to shine in market where it's
37:01
Speaker 1: been harder and harder to outperform and fixed income and
37:03
Speaker 1: so creating that long track record. Then as we saw
37:06
Speaker 1: the environment change and the interest rate regime change, we've
37:09
Speaker 1: really been able to benefit from that and deliver for clients.
37:12
Speaker 2: And when I think of securitized assets, we typically think
37:16
Speaker 2: of mortgages and things like that. What sort of securitized
37:19
Speaker 2: assets so you guys playing with.
37:21
Speaker 1: Yeah, certainly mortgages is on the list. I'd also say
37:24
Speaker 1: asset backed securities, which can include things like you know,
37:28
Speaker 1: credit card receivables or car loans or things like that
37:31
Speaker 1: that I think are more consumer oriented. And so that's
37:34
Speaker 1: an area where there's been a lot of concern as
37:37
Speaker 1: concern about recession, you know, ebbs and flows. You definitely
37:41
Speaker 1: see people's concern about asset back securities move in line
37:43
Speaker 1: with that.
37:44
Speaker 2: Yeah, the recession concerns seem to have been a perennial
37:48
Speaker 2: miss since the last recession, since the COVID recession, right,
37:52
Speaker 2: which was a hot minute, and then all people were
37:57
Speaker 2: doing was expecting recession in twenty one, in twenty two,
38:00
Speaker 2: and even during the downturn in the market in twenty two.
38:04
Speaker 2: This is it, this is what's going to finally cause
38:05
Speaker 2: a recession and then a giant snap back in twenty three.
38:09
Speaker 2: I know, you guys are bottoms up stock pickers. How
38:13
Speaker 2: impactful is all that macro noise on your process?
38:19
Speaker 1: I mean, I'd say it actually creates more opportunity than anything,
38:21
Speaker 1: because when the market starts really worrying about a recession,
38:24
Speaker 1: then it generally undervalues companies that are more cyclical and
38:29
Speaker 1: in terms of their long term cash flow generating abilities.
38:32
Speaker 1: And when the market's not at all worried about a recession,
38:35
Speaker 1: then you can generally find opportunities in more defensive areas
38:39
Speaker 1: of the market. And so we do try to kind
38:41
Speaker 1: of keep in mind where we think the economic outlook
38:45
Speaker 1: could be causing a different short term perspective than a
38:48
Speaker 1: longer term perspective.
38:50
Speaker 2: So twenty twenty two must have been A friend from
38:54
Speaker 2: the military always describes that as a target rich environment.
38:57
Speaker 2: What were you guys doing in twenty twenty two when
39:00
Speaker 2: the SMP was down about twenty percent and the Nasdaq
39:03
Speaker 2: was down about thirty percent.
39:05
Speaker 1: Yeah, I mean, I think those are good examples, but
39:08
Speaker 1: I actually think the environment is better right now because really, yes,
39:12
Speaker 1: because we're in a situation where while the market is up,
39:16
Speaker 1: you know, double digits for this year, that's really a
39:19
Speaker 1: kind of high level perspective that really obscures what's going
39:23
Speaker 1: on under the surface, where there's a tremendous amount of volatility.
39:26
Speaker 1: We're seeing the performance of individual companies vary widely and
39:30
Speaker 1: is not at all representative of that high level market return.
39:34
Speaker 1: And so it's kind of like the Iceberg analogy, right.
39:37
Speaker 1: It looks tiny from the surface, but when you dig underneath,
39:40
Speaker 1: there's actually a lot more noise going on, and that
39:44
Speaker 1: really leads to a lot of idiosyncratic risk, which is
39:46
Speaker 1: what we look for. We want companies that are going
39:48
Speaker 1: to sell off when they miss their earnings or you know,
39:52
Speaker 1: create opportunities because of short term focus that can be
39:55
Speaker 1: overlooked for a long term investor.
39:57
Speaker 2: And we're recording this in July, so let's put some
40:00
Speaker 2: numbers out there. The first half of the year of
40:04
Speaker 2: twenty twenty four SMB five hundred up I think fifteen
40:07
Speaker 2: point three percent, but the average stock in the S
40:11
Speaker 2: and B five hundred was only up about six percent
40:13
Speaker 2: and change for the first half of the year. And
40:16
Speaker 2: I want to say, the average stock in the second
40:18
Speaker 2: quarter in the SMP was slightly negative. That's right down,
40:22
Speaker 2: down one point three percent something along those lines.
40:24
Speaker 1: Yep.
40:25
Speaker 2: So really that seems to really show you what a
40:29
Speaker 2: wide dispersion we have in performance. How does that play
40:34
Speaker 2: into your bottoms up stock picking?
40:36
Speaker 1: I mean, I think it creates opportunity because we see
40:39
Speaker 1: companies getting sold off that are really great fundamental businesses
40:44
Speaker 1: but you know, perhaps are going through a tough time
40:46
Speaker 1: or miss earnings for whatever reason. On the flip side,
40:49
Speaker 1: you see companies that you know, we really believe in
40:52
Speaker 1: and fundamentally in the long term, that we may already own,
40:55
Speaker 1: also selling off, or companies like the ones leading the
40:59
Speaker 1: market that have been doing so well. And the interesting
41:03
Speaker 1: thing I think about those top five companies is that
41:06
Speaker 1: they're actually very fundamentally strong. Now, it's not like we're
41:09
Speaker 1: seeing companies that are so ridiculously overvalued. They are much
41:13
Speaker 1: more highly valued than the market on average, but that's
41:17
Speaker 1: partially driven by earnings revisions and people, you know, realizing
41:21
Speaker 1: more and more how much cash flow those businesses can generate.
41:24
Speaker 1: I think what it's teeing up for is a future
41:26
Speaker 1: environment where anything that causes some instability for those extra
41:31
Speaker 1: large tech companies that are driving the market will really
41:33
Speaker 1: create a very different, high level environment for the market
41:36
Speaker 1: that will create opportunities for people who are really focused
41:39
Speaker 1: on bottom up investing.
41:40
Speaker 2: I'm glad you brought up that these aren't like just
41:43
Speaker 2: ephemeral ideas like we saw in the dot com era.
41:47
Speaker 2: I think the numbers on the Magnificent Seven collectively they
41:51
Speaker 2: do about two trillion dollars in revenue and about three
41:54
Speaker 2: hundred billion dollars in profits. Those are giant numbers, kind
41:59
Speaker 2: of hard to argue there's a bubble amongst them. Hey,
42:02
Speaker 2: there's some speculation and there's a little bit of over enthusiasm,
42:06
Speaker 2: but these are really very very well run. We'll manage
42:10
Speaker 2: companies that have become money printing machines.
42:13
Speaker 1: Yes, I mean, I think that is true. There's still
42:16
Speaker 1: a valuation consideration to be applied, and I think you
42:20
Speaker 1: could argue that they're not meaningfully overvalued right now, but
42:23
Speaker 1: it really all comes down to the future growth expectations
42:25
Speaker 1: and their ability to keep on delivering like this. And
42:28
Speaker 1: so you know, if for whatever reason, you know, regulation
42:32
Speaker 1: or some change in the environment caused that to slow down,
42:35
Speaker 1: then then it's a lot harder to justify these valuations.
42:38
Speaker 2: I was clicking around the website looking at some of
42:41
Speaker 2: the white papers you guys put out on a regular basis.
42:44
Speaker 2: Let's talk about one or two of those, uncovering opportunities
42:48
Speaker 2: in commercial real estate, the power of location. Let's talk
42:52
Speaker 2: about stepping into a dangerous area. I think the for
42:58
Speaker 2: office space anyway per square foot nationally has fallen from
43:02
Speaker 2: about three point fifty to one ninety nine. Tell us
43:05
Speaker 2: a little bit about opportunities in commercial real estate.
43:08
Speaker 1: I think commercial real estate, as our bond managers would say,
43:11
Speaker 1: is you know, clearly an area where the baby gets
43:15
Speaker 1: thrown out with the bathwater. And so if you focus
43:17
Speaker 1: on super high quality opportunities, then I think you can
43:20
Speaker 1: really find, you know, misprice securities essentially, because everybody is
43:25
Speaker 1: so worried about commercial real estate, and that worry is
43:28
Speaker 1: not without reason. To your point, it's.
43:30
Speaker 2: Particularly an office space, but there's a lot more to
43:32
Speaker 2: commercial real estate than just office space.
43:34
Speaker 1: Absolutely, But I think in you know, very high quality office.
43:38
Speaker 1: They're finding opportunities as well, and so it's partially I
43:42
Speaker 1: think a matter of looking for where investor expectations get
43:47
Speaker 1: so lumped together with the overall category, and the bottom
43:50
Speaker 1: up perspective can show actually there are individual buildings or
43:54
Speaker 1: opportunities in commercial real estate that can provide opportunity.
43:57
Speaker 2: What about geographies? Diamond Hill is low in the United States,
44:01
Speaker 2: but it seems that your experience has been all over
44:04
Speaker 2: Australia and Asia. Japan has had a great year. We're
44:08
Speaker 2: starting to see signs emerging market is doing better. Europe
44:12
Speaker 2: the perennial laggard, even Europe is starting to show signs
44:15
Speaker 2: of coming alive. How do you look at the rest
44:17
Speaker 2: of the globe. What are your constraints?
44:20
Speaker 1: So we have an international equity team that really focuses
44:23
Speaker 1: on looking for opportunities outside the US, and they travel
44:26
Speaker 1: the world meeting with management teams and you know, really
44:29
Speaker 1: uncovering the death that you can't get just by you know,
44:33
Speaker 1: staying in the US looking at the data. They do
44:36
Speaker 1: obviously spend a lot of time doing that, but I'd
44:39
Speaker 1: say that's really led to a focus on areas that
44:43
Speaker 1: are more bottom up oriented. So you know, just like
44:46
Speaker 1: on the US side, we're really looking for individual companies
44:49
Speaker 1: that lead to opportunity. But you do occasionally find areas
44:52
Speaker 1: of the globe where you know you either want to
44:55
Speaker 1: avoid it wholeheartedly, even if there might be a company
44:57
Speaker 1: that looks interesting, or where there's a lot of undervalued
45:01
Speaker 1: businesses that we can invest in. And I do think
45:04
Speaker 1: that among technology, which is, you know, a very international industry,
45:09
Speaker 1: very global industry, there are some opportunities there because when
45:14
Speaker 1: you look at names like TSMC and Samsung that are
45:19
Speaker 1: really fundamentally great businesses even before AI caused things to
45:23
Speaker 1: go crazy. I think that's just an area where our
45:26
Speaker 1: team's finding a lot of opportunity.
45:28
Speaker 2: What about strategic capacity management? How does that improve client outcomes?
45:35
Speaker 1: So essentially that kind of goes back to what we
45:37
Speaker 1: were talking about before, where it's really important to consider
45:40
Speaker 1: the capacity of strategies that we manage so that we
45:43
Speaker 1: can put our existing clients interests first. And so when
45:47
Speaker 1: we look at how much we think we can manage
45:50
Speaker 1: in a strategy, we try to take into consideration what
45:52
Speaker 1: the investor experience will be. And you know, if you're
45:56
Speaker 1: looking at small cap for example, I think it's easy
45:59
Speaker 1: for people to understand this where you know, we can
46:02
Speaker 1: clearly see that small cap managers that take on too
46:05
Speaker 1: many assets tend to have a much harder time uperforming
46:08
Speaker 1: the market over the long run. So we just explicitly
46:11
Speaker 1: say we think we can manage about you know, two
46:14
Speaker 1: two and a half billion dollars in small cap and
46:16
Speaker 1: when we get to that point, then we're not going
46:18
Speaker 1: to take new clients because it's really important for us
46:20
Speaker 1: that the client experience is more important than our ability
46:23
Speaker 1: to generate more revenue by bringing on more assets.
46:25
Speaker 2: And what about long short. You have a fund that
46:28
Speaker 2: runs long short, tell us a little bit about that.
46:31
Speaker 2: What's the thinking When I hear bottoms up stock picking?
46:35
Speaker 2: I no longer think about short selling. But obviously if
46:39
Speaker 2: you identify something that is mispriced to the downside, perhaps
46:44
Speaker 2: you can also identify things mispriced to the upside.
46:47
Speaker 1: Yeah, that's basically the philosophical approach that we've taken. And
46:51
Speaker 1: I'd say there's a few people on our team, one
46:54
Speaker 1: of the portfolio managers on that strategy, and a couple
46:57
Speaker 1: of analysts who have really developed expertise thinking about the
46:59
Speaker 1: shorts and so, but fundamentally it really is about valuation. Now.
47:04
Speaker 1: It's harder, obviously when you're trying to short an overvalued
47:07
Speaker 1: company than buying an undervalued one, because you can only
47:10
Speaker 1: wait so long if the stock's running against you. But
47:14
Speaker 1: we've just really developed an approach I think that takes
47:17
Speaker 1: a little bit more of a diversified approach on the
47:20
Speaker 1: short side and gives a little bit more room to
47:22
Speaker 1: situations that might might not unfold as quickly as you hope.
47:25
Speaker 2: Are these one thirty thirty funds or are they market
47:28
Speaker 2: neutral funds? How do you structure them?
47:31
Speaker 1: They are essentially sixty percent that long. So that's been
47:35
Speaker 1: our focus historically and really what our clients have asked
47:38
Speaker 1: of us. But it is an area that I think
47:40
Speaker 1: could be ripe for innovation because it is easier to
47:44
Speaker 1: think about, you know, market neutral strategy in an environment
47:46
Speaker 1: where interest rates are positive than it is when they're zero,
47:50
Speaker 1: and so I think, you know, not to say you
47:52
Speaker 1: couldn't do it when they're zero, but I just think
47:54
Speaker 1: it's a lot harder to make the math work.
47:56
Speaker 2: Tina made it very difficult to be on the short
47:58
Speaker 2: side when was no alternative to equities. Was pretty much
48:02
Speaker 2: the only place, only place you could go, but today
48:05
Speaker 2: with rates over five percent, I think the last time
48:08
Speaker 2: I looked at the money market fund it was about
48:10
Speaker 2: five and a quarter somewhere around then. I know you
48:14
Speaker 2: when we were talking about fixed income, you mentioned securitized assets.
48:19
Speaker 2: What about other forms of private credit? It's been probably
48:23
Speaker 2: the hottest area in the market over the past few years.
48:26
Speaker 1: Yeah. I mean, whenever there's an area of the market
48:28
Speaker 1: that is hot, I would say my first instinct is
48:31
Speaker 1: don't go there. And private credit, I think, I think
48:35
Speaker 1: there are a lot of reasons why private credit has
48:37
Speaker 1: done so well. But you know, and I do think
48:40
Speaker 1: the line is a little blurry in fixed income, and
48:42
Speaker 1: sometimes people call things private credit that are arguably in
48:46
Speaker 1: scope for some things that we might take a look at.
48:49
Speaker 1: But we do not have private credit strategies, and we
48:52
Speaker 1: do not intend to, because you know, we've really been
48:55
Speaker 1: focused on the areas of fixed income where we can
48:57
Speaker 1: identify dislocation, and so that's really what we feel like
49:01
Speaker 1: we can do in that core and short ration securitized strategies.
49:04
Speaker 2: I only have you for a few minutes more. Let's
49:07
Speaker 2: jump to our favorite questions that we ask all of
49:10
Speaker 2: our guests, starting with what's been keeping you entertained these days?
49:14
Speaker 2: What are you watching or listening to?
49:17
Speaker 1: So one show I've really enjoyed is The Bear. I
49:20
Speaker 1: haven't watched the third season yet, but.
49:22
Speaker 2: We're about halfway through it and it's really interesting.
49:25
Speaker 1: Okay, good. I just think it's a great show. First
49:27
Speaker 1: of all, I'm from Chicago, and so I love the
49:29
Speaker 1: Chicago connection and constant visuals from my favorite city. And
49:34
Speaker 1: then I just think their character development is unbelievable. So
49:38
Speaker 1: it's been I've really enjoyed it.
49:40
Speaker 2: Well, not just Bear and Sydney, but watching Richie develop
49:45
Speaker 2: into from a caricature to a person has really really
49:49
Speaker 2: been fascinating, culminating with the Forks episode, I think with
49:53
Speaker 2: season two really was very amazing. Let's talk about your
49:57
Speaker 2: mentors who helped shape your career.
50:00
Speaker 1: So I was very fortunate early on in my career
50:03
Speaker 1: to have a couple of kind of managers and leaders
50:06
Speaker 1: that really helped set the stage for a productive future career.
50:10
Speaker 1: Even at Bank of America. While I didn't end up
50:12
Speaker 1: staying there a tremendously long time, I had the most
50:15
Speaker 1: incredible first manager, and he really helped me see that
50:19
Speaker 1: there were lots of different areas in finance and investing
50:22
Speaker 1: to go into and that he'd be supportive regardless, and
50:26
Speaker 1: I actually still keep in touch with him to this day.
50:29
Speaker 1: And then even at Dreehouse, I had a great manager
50:32
Speaker 1: and the international portfolio manager at the time, and he
50:35
Speaker 1: really taught me about the kind of fundamental aspects that
50:38
Speaker 1: all investing holds, even more momentum oriented investing. But he
50:43
Speaker 1: also was someone I've turned to in the past to
50:45
Speaker 1: ask deep career questions and kind of figure out where
50:48
Speaker 1: to go next.
50:49
Speaker 2: So let's talk about books, and I have to mention
50:52
Speaker 2: your book, Why Motes Matter, tell us a little bit
50:55
Speaker 2: about that, and then we'll jump into what you're reading currently.
51:00
Speaker 1: So Why Modes Matter was really an encapsulation of thinking
51:03
Speaker 1: about competitive advantage and valuation and making investment decisions, and
51:08
Speaker 1: that does encapsulate morning Stars investment philosophy, and certainly they
51:11
Speaker 1: commissioned the book or funded it, I would say, but
51:15
Speaker 1: it was a really great experience too because we were
51:17
Speaker 1: able to get a lot of the equity research team
51:20
Speaker 1: involved in writing it. So you'll see different chapters authored
51:23
Speaker 1: by multiple people, which I think was just a really
51:25
Speaker 1: great way to highlight some of the ways that you
51:28
Speaker 1: can apply competitive advantage thinking to different industries.
51:31
Speaker 2: And tell us about what you're reading now and what
51:34
Speaker 2: are some of your favorite books.
51:36
Speaker 1: So I just started Shipwar. I don't know if you've
51:38
Speaker 1: read that, but I have it.
51:39
Speaker 2: It's in my queue. I haven't started it yet, but
51:42
Speaker 2: everybody seems to love it.
51:43
Speaker 1: It's fascinating, and I think the thing that's so great
51:46
Speaker 1: about it is there's just so much around the topic
51:49
Speaker 1: of semiconductors and Silicon Valley and AI and like really
51:53
Speaker 1: just understanding the fundamental underpinnings of how the industry got
51:57
Speaker 1: started and where the power lies and why TSMC is
52:00
Speaker 1: such a critically important company to the whole world. I
52:03
Speaker 1: think everyone should read it, And I also like it
52:06
Speaker 1: because it kind of falls into my favorite category of
52:09
Speaker 1: nonfiction written like a novel or you know sometimes that
52:13
Speaker 1: dabbles into a historical fiction. There's I don't know if
52:16
Speaker 1: you've read The Devil in the White City. That's a
52:19
Speaker 1: great book that's really about kind of Chicago during the
52:21
Speaker 1: World's Fair.
52:22
Speaker 2: Larsen, Yeah, Eric Larson, Yeah, I have a whole stack
52:26
Speaker 2: of his stuff. Everything he writes is so fascinating and
52:30
Speaker 2: dense and absolutely reads like a novel.
52:33
Speaker 1: Yeah. I read something else, I can't remember the name
52:35
Speaker 1: of it, about the evolution of Edison and Tesla and
52:38
Speaker 1: Westinghouse right around the turn of the century. That I
52:41
Speaker 1: think is another fascinating example of this category where you
52:45
Speaker 1: know you're learning about real events and people, but in
52:47
Speaker 1: a way that feels like you're reading a novel. So
52:49
Speaker 1: I think there's a lot of great examples like.
52:51
Speaker 2: That, really really interesting. Our final two questions, what sort
52:55
Speaker 2: of advice would you give a recent college graduate interested
52:59
Speaker 2: in a career either investment management or finance.
53:03
Speaker 1: I'd say two things. First, seek experiences that will help
53:07
Speaker 1: you get the role that you think you want in
53:09
Speaker 1: the long term. And that one is really I think
53:12
Speaker 1: about not only getting experiences from your job and what
53:15
Speaker 1: you're doing day to day, but also, you know, looking
53:18
Speaker 1: for opportunities to you know, let's say you're an equity analyst,
53:21
Speaker 1: but you want to move into a leadership role. You
53:23
Speaker 1: can try to volunteer in organizations or serve on the
53:26
Speaker 1: board of a nonprofit that can help develop leadership skills,
53:30
Speaker 1: even though your day to day job much may be
53:32
Speaker 1: much more you know, investment oriented, for example. And another
53:36
Speaker 1: thing i'd always I always tell people who ask me
53:38
Speaker 1: this question, is it's so important to put your hand
53:41
Speaker 1: up and make sure that your manager knows how you
53:43
Speaker 1: want your career to evolve, because people, I think, assume
53:47
Speaker 1: that they're going to get tapped for their next role,
53:49
Speaker 1: and I just don't think it generally works that way.
53:51
Speaker 1: I think if you can be proactive and saying I
53:54
Speaker 1: would love to be an analyst on a different sector,
53:56
Speaker 1: or I'd love to be a portfolio manager someday or
53:59
Speaker 1: whatever it is that you aspire to, then you can
54:01
Speaker 1: work with your manager on making sure you have kind
54:03
Speaker 1: of a long term plan for developing the right skills
54:06
Speaker 1: instead of just being disappointed when you don't get the job.
54:09
Speaker 2: And our final question, what do you know about the
54:11
Speaker 2: world of investing today you wish you knew thirty or
54:14
Speaker 2: so years ago.
54:16
Speaker 1: I would say that trends last longer than you think
54:18
Speaker 1: they possibly could. And so I mean you could see
54:22
Speaker 1: that right now in the small cap versus large cap
54:26
Speaker 1: performance that we talked about. You could certainly see it
54:29
Speaker 1: even at the end of the dot com days. You know,
54:33
Speaker 1: you could see it even in like the two thousand
54:35
Speaker 1: and six two thousand and seven period where so many
54:38
Speaker 1: investors felt like they knew housing was going to collapse,
54:41
Speaker 1: but nobody could actually hold on to their positions long enough,
54:44
Speaker 1: except for very few to end up, you know, making
54:48
Speaker 1: that a positive trade. So I just think there's so
54:50
Speaker 1: many examples where trends go on so much longer than
54:53
Speaker 1: you think, So you need to make sure to take
54:55
Speaker 1: that into consideration in your future careers.
54:58
Speaker 2: Thank you, Heather for being so generous with your time.
55:01
Speaker 2: We have been speaking with Heather Brilliant, CEO of Diamond Hill.
55:05
Speaker 2: If you enjoy this conversation, well check out any of
55:08
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55:12
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55:44
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56:01
Speaker 1: But as think