A Global Perspective from Columbus, Ohio
Diamond Hill’s Global strategy will mark its five-year anniversary at the end of 2018. Given our belief that investment performance should be measured over five-year periods, the strategy’s upcoming anniversary also provides the first relevant performance measurement period.
As this milestone approaches, it’s useful to reflect on two foundational elements of the Global strategy’s investment process. First, the strategy is managed using the same intrinsic value investment philosophy, long-term perspective, and disciplined approach that is shared throughout the firm. Second, ideas are generated by our team of 30 industry-focused research analysts, who provide bottom-up analysis for all of our strategies. We believe that this combination of intrinsic value investment philosophy, depth of industry knowledge, and breadth of idea contribution will allow the Global strategy to generate competitive returns over full market cycles in the future.
Our consistent investment process, experienced portfolio management team, and industry-specialist research team clearly provide the firm a solid, long-term foundation for our existing domestic strategies. However, it’s appropriate to question if an Ohio-based firm with a limited track record of international investing will be able to execute its investment process effectively within the context of a global strategy. Put simply, the answer lies in our research team.
More than a decade ago, Diamond Hill’s senior management made the decision to build a large research team organized by sector. As assets under management grew, the research team increased in size as well. In 2008, Diamond Hill managed about $5 billion in assets and employed 26 investment team members, including 13 dedicated industry analysts. During the 2008 annual shareholder meeting, management stated that research analysts were the future of the firm and highlighted its commitment to investing in the research team. These statements proved accurate. Today, Diamond Hill manages $21 billion in assets and employs 48 investment team members, including 30 dedicated industry analysts.1
As the research team grew in size, each analyst was able to narrow their focus to a smaller group of industries. This narrowing of coverage allowed analysts to deepen their knowledge about the remaining industries under coverage. Similarly, analysts’ capacity for analyzing non-U.S. businesses within the smaller number of industries under coverage increased as well.
In most cases, industry knowledge translates well from one country to another, as business models within industries are typically similar across geographies. For example, a European bank faces different market dynamics, regulatory regimes, and reporting requirements than a U.S. bank. Understanding how these differences affect valuation requires a considerable amount of work for any analyst, and for a generalist the task is daunting. However, the basic banking business model of providing loans and ancillary financial services is shared throughout the world. An experienced banking analyst can efficiently assess almost any bank’s profit drivers, asset and liability characteristics, management aptitude, market dynamics, and regulatory backdrop, regardless of country of operation.
Moreover, we believe that thorough coverage of many domestic industries increasingly requires thorough coverage of international industries. This has long been the case for domestic industries that face substantial international competition, such as autos, pharmaceuticals, semiconductors, and consumer packaged goods. Even when evaluating domestic industries that don’t generally compete globally, we find value in having working knowledge of market dynamics in other countries. For example, when evaluating the potential impact that the proposed merger of T-Mobile and Sprint might have on the U.S. wireless industry, we can look to Canada as an example of a wireless market that has historically been dominated by three carriers that operate under macroeconomic and regulatory conditions that are somewhat similar to conditions in the U.S.
Our internet coverage provides another example of the benefits associated with pursuing global industry knowledge. The Global strategy holds shares of Facebook, Alphabet, and China-based search engine provider Baidu, while Diamond Hill’s Research Opportunities Fund owns shares of all three businesses, as well as the China-based internet giant Tencent. Diamond Hill’s internet analyst, Varun Gupta, has global internet coverage responsibility, and therefore covers all four companies. These internet giants are quite unique and it would be naïve to apply a rigid analytical and valuation framework to all four. Still, the businesses do share some common attributes associated with economics, sources of competitive advantage, and business strategies.
In order to cover these four companies effectively, Varun follows global market dynamics in online advertising and social networking services. He analyzes and evaluates the competitive landscape, product features, user adoption, and regulatory framework by geography as part of his domain-specific industry focus. This provides Diamond Hill with unique insight as we evaluate future prospects for different products offered by different firms in different geographies. Varun’s primary research helps us see nuances that may have gone unnoticed in a generalist model. For instance, Facebook’s popular global messaging service application, WhatsApp, may appear to have similar monetization and user engagement prospects as Tencent’s highly entrenched WeChat messaging service in China. However, as we evaluate the competitive landscape globally for WhatsApp, we estimate that its users are less inclined to use some of WeChat’s unique features (such as payments and Miniprograms) should WhatsApp decide to roll out similar features. Thus, we estimate Facebook’s ability to monetize WhatsApp users is likely lower than Tencent’s ability to monetize WeChat users.
As a final example, our knowledge of Samsung and other Chinese, Android-based smartphone manufacturers, combined with our understanding of the pervasive and immersive nature of WeChat, lead us to recognize that Apple’s competitive advantages of brand and customer switching costs are likely not as durable in China as they are in the U.S. and Europe. Our hardware analyst Jayant Jangra, who covers the smartphone industry, has an office that is just several feet from Varun’s office, and as a result these two communicate regularly. Knowledge sharing and cross-industry insights are natural occurrences when analysts work in close proximity to one another.
While the Global strategy went live nearly five years ago, our firm’s research analysts have had the ability to invest in international equities in Diamond Hill’s Research Opportunities Fund since 2009. In fact, the Research Opportunities Fund’s non-U.S. allocation has steadily increased over time. At the end of 2010, the Fund held just two international stocks, which accounted for about 1% of the Fund’s net asset value (NAV). At the end of October 2018, the Fund held shares of 14 international stocks, accounting for about 17% of NAV. As demonstrated in Exhibit 1, exposure to international stocks has grown steadily since the Fund’s inception.
EXHIBIT 1: RESEARCH OPPORTUNITIES FUND ALLOCATION TO INTERNATIONAL STOCKS
The Research Opportunities Fund is a very flexible strategy that is measured against a U.S.-only benchmark, the Russell 3000 Index. Additionally, there is no requirement for analysts to allocate to non-U.S. holdings. Therefore, the increasing international allocation in the Fund suggests that our research team is increasingly finding international investment opportunities that are equal to or better than the opportunities in the U.S.
It’s not surprising that our analysts routinely find attractively valued international stocks within their industry coverage. After all, the global opportunity set is much larger than the U.S. opportunity set, and we believe our research team is positioned to continue capitalizing on this international opportunity set in the future.
An investor should consider the Fund’s investment objectives, risks, charges, and expenses carefully before investing. The prospectus or summary prospectus contain this and other important information about the Fund(s) and are available at diamond-hill.com or by calling 888.226.5595. Please read the prospectus or summary prospectus carefully before investing. The Diamond Hill Funds are distributed by Foreside Financial Services, LLC (Member FINRA). Diamond Hill Capital Management, Inc., a registered investment adviser, serves as Investment Adviser to the Diamond Hill Funds and is paid a fee for its services. Diamond Hill Funds are not FDIC insured, may lose value, and have no bank guarantee.
1 As of November 30, 2018.
The Diamond Hill Research Opportunities Fund uses short selling which incurs significant additional risk. Theoretically, stocks sold short have the risk of unlimited losses. There are specialized risks associated with small capitalization issues, such as market illiquidity and greater market volatility, than large capitalization issues. Investing in non-U.S. securities may entail risk due to foreign economic and political developments; this risk may be higher when investing in emerging markets. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns.
Portfolio holdings are subject to change and will be made available at least monthly for download at www.diamond-hill.com/documents/mutual-funds/, typically on the seventh (7th) business day following the most recent month-end date.
As of November 30, 2018, Diamond Hill owned shares of Alphabet, Inc., Baidu, Inc., Facebook, Inc., and Tencent Holdings Ltd.
The views expressed are those of the research analyst as of December 2018, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.