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 struggle agricultural influence 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 buyers considered the sell-off as a chance to amass shares that bought sharply in January and February.

The Russell 1000 ended the quarter down 5.13%. Returns have 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 struggle and sanctions on the Russian vitality sector pushed up oil and gasoline 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 trade perspective.) Supplies have been up 7%, and utilities posted a modest 2% enhance within the first quarter.

Client discretion and healthcare led the remainder of the sector down, every reporting 15% losses. Know-how and trade 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 general market, our portfolio’s damaging returns nonetheless outperformed the Russell 2500 Index by a wholesome margin within the first quarter. The considerably decrease weight for healthcare offered a relative assist, as our property additionally outperformed our friends within the index. Energy between our shopper items and monetary holdings additionally helped ship outcomes, as did our underweight publicity to know-how, which took a success within the first half of the quarter. Our shopper discretionary holdings have been the largest supply of our relative weak point as financial uncertainty linked to increased inflation expectations returned. Our weaknesses within the supplies and vitality sectors outperforming the index have 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 important superior funding in cage-free amenities as some states have begun to transition to offering cage-free eggs solely, particularly California. Moreover, various opponents have encountered hen flu outbreaks of their amenities, driving up egg costs and highlighting the standard of CalMaine’s manufacturing capabilities.

The South Jersey Industries pure gasoline facility obtained a lift when it accepted a suggestion from a privately owned infrastructure fund to purchase the corporate at a 53% premium over its earlier shut. The worth quoted was in keeping with our long-term view of the corporate. Equally, through the first quarter, property and casualty insurer Alleghany introduced that it might 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 general 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 increased mortgage charges would dampen demand for brand new properties. We’re conscious of the challenges posed by the near-term increased rate of interest surroundings. In the long run, the secular view of housing development is constructive, as there’s nonetheless a bodily scarcity of housing inventory in the USA. We additionally just like the NVR method through which it’s an choice to land the land slightly than personal it completely, exposing the corporate to much less threat of falling land costs.

Leasing and lease providers 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 by means of a lease to personal contract is murky within the close to time period, because the trade begins to learn from the stimulus advantages of the prior 12 months. In our opinion, outcomes ought to enhance because the retail surroundings continues to open up. As PRG provides 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 era course of and asset-light enterprise mannequin. There are additionally alternatives for the corporate to develop a comparatively secure retail companion base and increase into e-commerce and direct-to-consumer channels.

Diversified know-how firm Colfax Company underperformed largely because of issues surrounding the corporate’s publicity to Russia in its manufacturing know-how 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 know-how section grew to become ESAB (ESABand a medical know-how enterprise organized below the Enovis identify.ENOV). ESAB eliminated Russia from its 2022 steering, 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 methods to repeatedly enhance operations over time and interact 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, buyers are questioning whether or not UGI Company, a pure gasoline and electrical energy utility, would possibly mismanage commodity threat or face some demand destruction. We imagine these dangers are transient and manageable. Moreover, UGI has made important investments in its renewable gas enterprise, together with Renewable Pure Fuel (RNG) and BioLPG-propane produced from renewable sources equivalent to plant and plant waste supplies. Industrial sensor developer, Sensata Applied sciences faces ongoing uncertainty within the auto trade linked to produce chain disruptions and shortages of semiconductor chips.

pockets exercise

New property within the first quarter included Civitas Sources (CIVI) and Dwell Oak Bancshares (lob). Power exploration and product firm Civitas offered a chance to study what we imagine are glorious, long-term property that might profit from increased vitality costs.

Fundamentals for regional financial institution Dwell Oak stay sturdy, though shares have been bought in sympathy with different financial institution names within the first quarter. The near-term weak point introduced a chance to start out a place at an organization we all know nicely – one which we imagine holds a singular place as a small enterprise financial institution and can also be a know-how 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 robust restoration in 2021, world GDP progress is anticipated to gradual in 2022, with the potential for extra stress from ongoing provide chain disruptions, increased 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 increased 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 stream of exports from these nations, probably affecting world provides and costs for a variety of finish markets. The potential influence on particular person firms varies, and we monitor these dangers carefully.

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 more likely to be decrease than historic averages.

Our main focus has at all times been to ship value-added outcomes to our present purchasers, and we imagine we are able to obtain higher market returns over the subsequent 5 years by means of energetic 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

Dwell 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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