Diamond Hill Small-Mid Cap Fund Q1 2022 Market Commentary

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market remark

The runaway quarter resulted in inventory markets with the worst returns because the first quarter of 2020. Rising inflation prompted the Federal Reserve to start a rate-raising cycle, whereas Putin’s invasion of Ukraine despatched commodity costs hovering (Study extra concerning the conflict agricultural impression In our final podcast) and the already challenged provide chain system in additional chaos. After the Federal Reserve raised rates of interest in March, some optimism once more crept into the markets as traders seen the sell-off as a chance to accumulate shares that bought sharply in January and February.

The Russell 1000 ended the quarter down 5.13%. Returns had been weaker under the market cap spectrum with the Russell Midcap down -5.68% and the Russell 2000 Index down -7.53%. Throughout the cap spectrum, shares within the worth indices have held up a lot better than their progress index friends. The Russell 1000 Worth Index outperformed its friends in progress by 830 foundation factors, whereas the Russell Midcap Worth and Russell 2000 Worth Indexes outperformed their friends in progress by greater than 1,000 foundation factors every.

Within the Russell 2500 Index, the vitality sector superior 40% because the Russian/Ukrainian conflict and sanctions on the Russian vitality sector pushed up oil and fuel costs within the first quarter. Brent crude reached a excessive of $140 a barrel in early March, a degree not seen because the world monetary disaster in 2008. Within the US, gasoline costs have jumped previous $4 a gallon, with expectations that costs may attain $5 on over the subsequent six months. (Study extra about The state of vitality markets In our most up-to-date business perspective.) Supplies had been up 7%, and utilities posted a modest 2% improve within the first quarter.

Client discretion and healthcare led the remainder of the sector down, every reporting 15% losses. Know-how and business got here second after the index with losses of -10% and -7%. The remaining sectors outperformed the index with single-digit declines.

1Q22 Russell Index Sector Returns 2500 (%)

Chart: 1Q22 Russell Index Sector Returns 2500 (%)

Supply: FactSet, as of March 31, 2022.

efficiency dialogue

Within the midst of a unstable quarter within the total market, our portfolio’s detrimental returns nonetheless outperformed the Russell 2500 Index by a wholesome margin within the first quarter. The considerably decrease weight for healthcare supplied a relative assist, as our property additionally outperformed our friends within the index. Energy between our client items and monetary holdings additionally helped ship outcomes, as did our underweight publicity to expertise, which took successful within the first half of the quarter. Our client discretionary holdings had been the most important supply of our relative weak spot as financial uncertainty linked to larger inflation expectations returned. Our weaknesses within the supplies and vitality sectors outperforming the index had been extra headwinds.

On a person holdings foundation, main shareholders returning within the first quarter included Cal-Maine Meals (calm), South Jersey Industries (SJI), Al-Ghani Basis (sand the Kirby Firmkiks). Recent egg producer Cal-Maine has benefited from its vital superior funding in cage-free amenities as some states have begun to transition to offering cage-free eggs solely, particularly California. Moreover, numerous rivals have encountered chicken flu outbreaks of their amenities, driving up egg costs and highlighting the standard of CalMaine’s manufacturing capabilities.

The South Jersey Industries pure fuel facility acquired a lift when it accepted a proposal from a privately owned infrastructure fund to purchase the corporate at a 53% premium over its earlier shut. The worth quoted was per our long-term view of the corporate. Equally, in the course of the first quarter, property and casualty insurer Alleghany introduced that it will purchase Berkshire Hathaway (BRK.A, BRK.B) for a 25% premium over its earlier market worth.

The Kirby Company, a U.S.-based bulk liquid product tanker transportation firm, benefited because the North American downturn in Omicron boosted demand for hydrocarbon distillates and improved total industrial exercise.

The exploration and manufacturing firm Coterra Power (CTRA). Power demand has elevated with the easing of COVID-related financial restrictions together with issues about provide disruptions associated to the Russian invasion of Ukraine.

Decrease shareholders within the first quarter included NVR Inc. (NVR), PROG Holdings (PRG) and Colfax Company. Homebuilder NVR, together with different housing firms, got here below stress within the first quarter totally on issues that larger mortgage charges would dampen demand for brand new properties. We’re conscious of the challenges posed by the near-term larger rate of interest surroundings. In the long run, the secular view of housing development is constructive, as there may be nonetheless a bodily scarcity of housing inventory in the USA. We additionally just like the NVR strategy by which it’s an choice to land the land slightly than personal it totally, exposing the corporate to much less threat of falling land costs.

Leasing and lease companies firm PROG Holdings noticed a drop in lease-to-own purposes in January whereas PRG’s retail companions struggled with retail and retailer worker visitors because of the omicron variable. Furthermore, the imaginative and prescient to the buyer via a lease to personal contract is murky within the close to time period, because the business begins to learn from the stimulus advantages of the prior yr. In our opinion, outcomes ought to enhance because the retail surroundings continues to open up. As PRG presents versatile rental buying options to assist extra credit-challenged prospects in the direction of product possession, a slack surroundings can spotlight the power of PRG’s enterprise mannequin. We proceed to be drawn to PRG’s comparatively high-quality money technology course of and asset-light enterprise mannequin. There are additionally alternatives for the corporate to develop a comparatively secure retail companion base and broaden into e-commerce and direct-to-consumer channels.

Diversified expertise firm Colfax Company underperformed largely because of issues surrounding the corporate’s publicity to Russia in its manufacturing expertise enterprise, which generated about 7% of income for that enterprise line. Instantly after the tip of the quarter, the corporate accomplished a deliberate division – the manufacturing expertise phase grew to become ESAB (ESABand a medical expertise enterprise organized below the Enovis identify.ENOV). ESAB eliminated Russia from its 2022 steerage, and with the cut up finalizing, we proceed to retain each, believing that the 2 new firms are in a superb place to leverage their enterprise techniques to repeatedly enhance operations over time and have interaction in value-creating acquisitions of their respective industries.

Different minimal shareholders embody UGI (UGI) and Sensata Applied sciences (Avenue). Taking a cue from Europe’s vitality disaster, traders are questioning whether or not UGI Company, a pure fuel and electrical energy utility, may mismanage commodity threat or face some demand destruction. We imagine these dangers are transient and manageable. Moreover, UGI has made vital investments in its renewable gasoline enterprise, together with Renewable Pure Gasoline (RNG) and BioLPG-propane produced from renewable sources corresponding to plant and plant waste supplies. Industrial sensor developer, Sensata Applied sciences faces ongoing uncertainty within the auto business linked to provide chain disruptions and shortages of semiconductor chips.

pockets exercise

New property within the first quarter included Civitas Sources (CIVI) and Stay Oak Bancshares (lob). Power exploration and product firm Civitas supplied a chance to find out about what we imagine are glorious, long-term property that would profit from larger vitality costs.

Fundamentals for regional financial institution Stay Oak stay sturdy, though shares had been bought in sympathy with different financial institution names within the first quarter. The near-term weak spot offered a chance to begin a place at an organization we all know effectively – one which we imagine holds a novel place as a small enterprise financial institution and can also be a expertise chief.

Webster Monetary Company (WBS) can also be a brand new identify within the portfolio, having accomplished its merger with our former Sterling Financial institution. This mixture implies that Webster’s massive Well being Financial savings Account (HSA) platform, which is an efficient supply of low-cost deposits, can be paired with Sterling’s natural mortgage creation engine.

We obtained out of the American Reinsurance Group (RGAand Molson CoorsFaucet) in favor of the names of the best conviction.

market forecast

After a powerful restoration in 2021, world GDP progress is anticipated to sluggish in 2022, with the potential for added stress from ongoing provide chain disruptions, larger oil costs and different impacts from the Russian invasion of Ukraine. Regardless of these headwinds, company earnings are anticipated to proceed to succeed in new heights in 2022.

The sharp financial restoration in the USA, together with unprecedented fiscal and financial stimulus, elevated wage progress and provide and demand tightening, has led to larger ranges of inflation. The Federal Reserve has begun elevating rates of interest and ending quantitative easing, however it might have to be extra extreme if inflation continues at elevated ranges, which may very well be a headwind for inventory markets.

The Russian invasion of Ukraine has the potential to disrupt the movement of exports from these nations, probably affecting world provides and costs for a variety of finish markets. The potential impression on particular person firms varies, and we monitor these dangers intently.

Whereas the year-to-date decline in inventory markets has created some funding alternatives, broad market valuations are nonetheless above historic averages. From present ranges, inventory market returns over the subsequent 5 years are prone to be decrease than historic averages.

Our main focus has all the time been to ship value-added outcomes to our current shoppers, and we imagine we will obtain higher market returns over the subsequent 5 years via lively portfolio administration.

Listed securities and respective weights (%)

Al Ghani Firm

2.5

NVR, Inc.

2.4

Cal-Maine Meals, Inc.

3.4

PROG Holdings, Inc.

1.1

Civitas Sources, Inc.

0.6

Sensata Applied sciences Holding PLC

2.4

Colfax Company.

4.1

South Jersey Industries, Inc.

2.1

Coterra Power, Inc.

2.4

UGI Company.

2.1

Kirby Company.

2.1

Webster Monetary Corp.

3.8

Stay Oak Bancshares, Inc.

0.5

Interval and whole annual returns (%)

Since incorporation (December 30, 2005) 15 p 10 am 5 am 3 years 1 p YTD 1Q22 Expense Ratio (%) Whole

Expense Ratio (%) Internet1

first diploma (DHMIX) 9.32 9.35 11.51 8.79 13.08 11 -3.07 -3.07 0.93 0.92
2500 . Russell Index 9.50 8.98 12.09 11.57 13.79 0 -5.82 -5.82
Russell worth index 2500 8.40 7.59 11.04 9.19 12.98 8 -1.5 -1.5


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