Welcome to the Diamond Hill Second Quarter 2017 Equity Portfolio Manager Call. My name is Tilda and I’ll be your operator for today. At this time, all participants are in listen-only mode. Later, we’ll conduct a question-and-answer session. [Operator instructions] Please note that this conference is being recorded.

I’d now like to turn the call over to Ms. Kristen Sheffield, Portfolio specialist. Ms. Sheffield, you may begin..

Thank you. Good afternoon, everyone and welcome to the Diamond Hill second quarter equity portfolio manager conference call. Thank you for joining us this afternoon. My name is Kristen Sheffield. On today's call, our equity portfolio managers will provide commentary on their respective funds, which will be followed by an opportunity for Q&A.

As a reminder, we'll host a separate fixed income portfolio manager call at 2.00 PM Eastern Time tomorrow. Dial-in information is available on the home page of our website and we hope you will join us. When we're ready for the Q&A session, the operator will provide instructions if you want to ask a question over the phone.

You can also type a question on your screen at any time throughout the call. As always, we have a few important compliance statements to go over before we begin. The opinions expressed by our portfolio managers are their own and are subject to change at any time as circumstances change.

Any discussion of specific portfolio holdings will be as of June 30, 2017. Portfolio holdings are subject to change without notice and a complete list of portfolio holdings as of June 30, 2017 is available on our website. This next slide provides additional important disclosures. We encourage you to read these carefully at a later time.

I'll now hand the call over to Tom Schindler, Portfolio Manager of the Small Cap Funds.

Tom?.

Thanks. The Diamond Hill Small Cap Fund increased slightly less than 1% in the second quarter, trailing at nearly 2.5% return of the Russell 2000 Index and ahead of the 0.67% return of the Russell 2000 Value Index.

In the first of 2017, larger company stocks have outperformed small caps and growth indices have outperformed value indices, partially retracing what occurred in the fourth quarter of 2016.

And looking at the fund by sector in the second quarter, strong performance in the consumer discretionary sector was more than offset by weak performance in industrials, the relative lack of investments in information technology and cash. In terms of individual holdings, the biggest contributor in the quarter was Alere.

Our investment in Alere has taken several twists and turns. In February 2016, Abbott and Alere announced their intention for Abbott to acquire Alere for $56 per share in cash, a transaction we believe made strategic sense for Abbott fully valued Alere on a public market basis and offered a significant premium should then $37 stock price.

But for the remainder of 2016, the deal encountered several snags as Alere needed to restate earnings in the company's Arriva Medical business that offered diabetes-related tests through the mail to Medicare and Medicaid patients was kicked out of CMS for contentions of billing misconduct.

Abbott attempted to back out of the deal and the companies countersued each other. After early hearings in the case, the companies agreed to renegotiate the price to $51 per share, which was announced in April. The market was assigned fairly low probability to the deal actually closing.

So, the stock rallied when this was announced and the deal now looks on track to close this quarter. While the overall outcome is satisfactory, it has taken much longer and at a lower price than originally planned. Aaron's performed fairly well in the quarter.

The company continues to make great strides in its progressive business that's growing in the mid-to-high teens, while the physical stores for Aaron's continue to show a decline in same-store sales.

Live Nation continues to dominate the live music concert business and also make great strides in both Ticketmaster and sponsorship in the concert business. Looking at worst performers, Cimarex similar to a lot of other E&P energy companies has suffered because of lower commodity prices. I've talked a lot about Avis Budget in the past.

Its first quarter earnings were very poor, but at the time gave some optimism that the second half would show improvement. Recent checks have shown that things like OEM orders to railcar companies have declined significantly with that. Hopefully will return the supply-demand back closer into balance by the end of the second quarter.

Also during the quarter, Avis announced a very early agreement with Waymo, which is Google self-driving effort to manage just a few vehicles in there.

And Phoenix, this has very little current financial ramifications, but what it does do is signify that Avis contention that it's got core competencies for managing a large fleet that might be needed in the future for these technology-related companies that are working on autonomous driving and does give you some credence to that contention.

[Grip] was down materially in the second quarter because intermodal pricing has been somewhat weak. We're optimistic that that has seen the bottom if might not pick up immediately, it seems to have stabilized in the meantime. I've very little in terms of changes to the -- that assets are median market cap.

While it looks like the percent in cash has been worked down and it has, I will note that because both Alere and Fortress Investment Group have announced deals for cash those are in cash are situations and when and if those deals do close, if we don't make other purchases in the fund, that cash could tick back up.

There were no new positions in the quarter, the three small eliminated positions. Global Sources we saw and we thought it was somewhat fairly valued on a public basis. After exiting our position, they did announce that they were being acquired for a substantial premium. So that was unfortunate, but it was fairly small position.

[Indiscernible] was a company that we received a very small allocation in when it was spun out of the former [Greatbatch]. That company has also -- has seen its price rise during the year. So, we exited our very small position in that. Lastly the Universal American, they had a deal with WellCare to be acquired.

That was announced during 2016 and it finally closed in the second quarter of 2017. So those are the eliminated positions. With that, I'll turn it back to Kristen..

Thank you, Tom.

Next, Chris Welch will provide comments on the small, mid and mid-cap fund results, Chris?.

Thanks Kristen. The small mid-cap strategy gained 1% in the second quarter, which trailed the benchmark Russell 2500 Index, which was up 2.1%. The strategy is ahead of the benchmark by decent margin over five years and since inception.

The primary drivers of underperformance in the second quarter were unfavorable stock selection in the consumables and industrial sectors and it was partially offset by favorable stock selection and consumer discretionary. Looking at the sector weights, there was little change in the sector weights.

Generally, there's been a low level of activity in the strategy. The cast continues to be toward the high end of my range near 10%. There are few new opportunities, in my opinion, valuations have been fairly full for many stocks in the small and mid-cap areas of the market that haven’t found a lot of new opportunities.

And then I'll just note that the energy sector, you can see it 2.5% weight, that's been steadily down over the past few years as recently as 5.5 years ago, that sector was 15% of the weight in the portfolio as has been increased supply with both the oil and natural gas side of things that's restricted some of the attractive investment opportunities.

Looking at portfolio statistics, you see the 16% turnover in the trailing 12 months lower typically than kind of the 20% to 30% turnover range we've probably averaged over the long amounts of time. Again, that's not too many new opportunities that we're finding. So that's led to a little bit lower turnover.

One new position we did buy during the quarter was Avnet, which is a technology distribution business. Avnet struggled from a couple of things.

There's been some consolidation among their suppliers and that's resulted in a loss of business in a couple of cases, the competitors and then they also stumbled with an internal supply chain software installation recently that led to increased costs. However, they did upgrade their business by selling a more commoditized division recently.

They have a very strong balance sheet and because of some of their stumbles, the stock fell to a very attractive price. We believe that the main semiconductor distribution business is still a necessary business, still adds value to their customers.

We took a small position at 50 basis points during the quarter and then Tom referred to the Universal American, that was acquired out of the portfolio.

Moving on to the mid-cap strategy, we had a positive return in the second quarter, but it trailed the benchmark and since the inception of the strategy, which is now 3.5 years, we've also trailed the benchmark by a modest about.

The main factors driving the second quarter results relative to the benchmarks were unfavorable stock selection in the technology and consumer staples sectors and again that was partially offset similar to Smith by the favorable stock selection and consumer discretionary.

Looking at sector weights, there is nothing unique that stands out in the sector weights. The cash shows us a little bit over 10% due to a modest quarter end inflow that was invested the next day. The cash has been fairly steady in the 9% to 10% range for the past month or two.

Then finally, in terms of portfolio statistics, new and eliminated positions 14% turnover over the past 12 months and one new position that's in addition to the Avnet that I mentioned previously. Verisk Analytics is a data analytics provider with about three quarters of their business coming from property and casualty insurance industry.

They have unique data, which is very high-value add and as result, they have very high retention of customers over time. The valuation of the stock gives them some credits for these favorable characteristics, but we still think there's room for excess investor returns at the current prices.

And then Broadridge was sold out of the portfolio that's been a successful long-term investment for us. They have a very solid investor communications and financial transaction processing business that approached our estimate of intrinsic value and we sold it in part. It was a small position.

We sold it in part to maintain our desired portfolio concentration, we target between 40 and 60 holdings in the mid-cap portfolio and at the end of the quarter we were at 59 holdings. So, with that, I will turn it back over to Kristen..

Thanks Chris. Chuck Bath will now provide comments on the large cap fund.

Chuck?.

Yeah. Thank you, Kristen and as you see, the performance for the portfolio for the quarter iShares was up 3% about in line with the 3.06% return for the Russell 1000 Index and then longer-term numbers were very happy with the outperformance of the one-year number and the five-year number and longer duration as well to.

So, we're pleased with the performance and relative terms and certainly in absolute terms as well to as the market performance has been quite strong for a few years now.

In terms of the individual portfolio itself I think their performance in large part was driven by the financial services names, thereby far the largest sector waiting in the portfolio and for Citigroup is one of the biggest contributors and also the largest holding in the portfolio.

The sector's performance did a little bit -- we did a little bit better in stock selection in there and the financial sector. I think more important than stock selection was the large waiting in a strong performing sector in market. So was the biggest contributor to the portfolio returns as well to healthcare.

Seattle and Abbott Laboratories were both strong contributors, Abbott quite as Tom hinted out with the Alere acquisition, I think just gained that issue resolved and it's helped Abbott and helped shareholders focus on core operations of Abbott and not these peripheral acquisition issues.

Alere was an issue that they needed to get behind and they did and then Aetna is representative of the strong performance of the continued strong performance of the managed care companies and it is a large hording and has done well since we purchased about a year ago.

In terms of the worst performers in the portfolio, as you might guess, energy and our One Energy Holdings Cimarex was the worst performer and also TJX, which is relatively I would use the word immune, but relatively well-positioned compatibility relative to what's going on in the retail space, but it's not totally immune.

So therefore, it was hurt as the same-store sales while we were not as good as the market hoped for. And then Capital One is a credit card company, who is disappointed in terms of their performance of their underlying credit card business.

Their asset quality has deteriorated to a level worse than I expected it to when I made the purchase and that you might see later on where we have purchased Discover Financial Services, a similar company and a competitor, but a better asset quality mix and as a result, we've been swapped -- we swapped some of our Capital One for Discover in the quarter, due to our concerns that Capital One was not meeting the asset quality targets, which we anticipated for them when we first made the investment.

In terms of the portfolio breakdown by sector, you'll see not that much change. The large waiting in financial certainly stands out and then also the energy waiting which is low and has gotten lower.

We've reduced -- this is a year-over-year change in the portfolio waiting that we've reduced our energy weighting in the portfolio, that combined with poor performance by energy stocks has caused it's waiting to go down. Those are the two highlights that gets along with case, which is low -- has been lower for quite some time and continues to be low.

Beyond that, not too much change in the sector waitings in the portfolio on a year-over-year basis. And then statistics, which are clearly available, I'll just highlight that the portfolio turnover at 22% is very typical. Number of equity holdings 52, a little bit high.

I think that probably reflects the fact a couple of names, which we may be close to eliminating, where it had not been eliminated by quarter end and so they still have 52 names in the portfolio and as you see, the cash level at 1.9%. New names of the portfolio; Discover, which we mentioned earlier, a higher quality business than Capital One.

Molson Coors Brewing Company, which is an inexpensive staples company.

It is as it says, it's a brewing company, a large holder of mature large brands in the -- not mostly in the United States, which is in the process of consolidating and there's opportunities for Molson subsequent to their purchase -- buying out minority shareholders in their Miller business to add new cost savings for the business to help drive earnings growth in that manner.

And First Republic Bank, Wells Fargo has been in the news. We were concerned and rightly so has won regulatory and compliance issues and less so in profitability. That maybe what the Wells Fargo Organization needs to do but as shareholder, I was a bit concerned.

So, we swapped Wells Fargo for some of our -- some more PNC, which we owned and added in new very high-quality bank First Republic, which is not only high-quality, is also a local competitor in several Wells Fargo.

Chris Welch mentioned that and I am going to add further to that discussion, but those are the new names in the portfolio for the quarter, somewhat atypical quarter in terms of trading activity and portfolio structure, not too much different than it was at the end of last quarter. I think I'll conclude my remarks there and pass it back to Kristen..

Thank you, Chuck.

Next Austin Hawley will give us an update on the all cap select fund, Austin?.

Thanks Kristen. In the second quarter, the all cap select fund returned to approximately 1.5% trailing the Russell 3000 benchmark. It has been a strongly momentum-driven market throughout 2017 with the Russell 3000 Growth Index up 16% for yesterday compared to the 4% return for the Russell 3000 Value Index.

This type of environment, which rewards growth above all else can make it difficult to keep pace with the core indices and we've certainly felt the headwinds recently. In the quarter, the fund benefited from good security selection in healthcare and are underweighted exposure to the energy sector.

This was offset by poor security selection in our largest sector exposures; financials, consumer discretionary and industrials. Turning to the next slide, you can see some of our -- the key individual contributors, focusing on the worst performers in the quarter.

Both 21st Century Fox, and Consumer reported solid results, but were dragged down by shift in the sentiment towards their respective industries. Baja Group, Bank United and Liberty Global, all had short-term setbacks relative to investor expectations.

In each case, we believe these setbacks are transitory and we haven’t changed our long-term assumptions. Turning to the next slide in Sector Exposure, you can see the sector level changes for our portfolio.

Over the course of the past year we have trimmed our exposure to some of the strongest performing areas of the market; financials, industrials and technology. We've redeployed into consumer, both discretionary and staples as well as one position each in real estate and telecom.

In total, we believe we have modestly decreased the cyclicality of the portfolio and upgraded quality as the valuation gap between cyclicals and defensives has narrowed over the course of the past year. Turning to the next slide, you can see our new positions in the quarter, which are largely consistent with the tunes I talked about.

High quality businesses and more defensive industries. With that, I'll turn it back to Kristen..

Thanks Austin. Next Chris Bingaman, Portfolio Manager for the Long-Short fund will provide and update on recent results..

Thanks Kristen. The Diamond Hill Long-Short fund was up roughly 70 basis points in Q2 versus roughly 190 for our 60-40 blended benchmark. The results lagged that bench due primarily to on the long side, less tech exposure generally.

In the short book four or five holdings, primarily in the industrials, tech and discretionary areas where the drags in the quarter. Turning to best and worst performers, again the long portfolio was generally in line with the benchmark. The shorts were really the drag.

You can see the best performers, some of these have already been addressed by other portfolio managers. Generally speaking, it's the larger positions that were the drivers. On the positive side, the one exception would be Alere. Tom and Chuck, both mentioned that.

Definitely a unique situation, unique to long-short and that we bought the stock before the deal was originally announced in 2016. We're very pleased with the announcement that they were selling for the price they were to Abbott. We sold those shares after that announcement and then reentered the position.

As Tom mentioned, it seems like the market when the deal seems like it might have some challenges and there was legal action back and forth, it seemed like the market was assigning a very, very low probability that the deal was going to happen.

We thought the odds were a little bit higher, reentered the position and that's worked again as they settled that as Tom mentioned. On the flipside, the drags again were a few of the short names primarily. Cimarex was a long -- other PMs have mentioned, we don't have a lot of energy exposure.

So, while Cimarex was a little bit of a drag, we don't have a lot of exposure overall. That's really our only long holding there and Fox was mentioned.

On the short side, I'll just mention one, your Best Buy has been a very poor performer in the portfolio for the last few quarters and the reaction last quarter to their quarterly announcement surprised us quite a bit. The stock was up very strongly on what looks to us like another quarter of very challenging topline trends.

Traffic continue to be negative. Most of the positive seem to be primarily on the cost side and so we're a bit skeptical at the current valuation and skeptical that the company can avoid some of the long-term pressures that seem to be inevitable for most retailers. Continuing on sector allocation, no real big changes there as is the norm.

Real quickly, I'll just highlight financials and consumer staples.

A year ago, we were talking about the opportunities on the long side in financials and how difficult it was in lots of low volatility, quote unquote, “defensive bond-like areas” staples being one of those and you can see, since then that was sort of the peak exposure for both of those two sectors long financials and short Staples and since then, we've reduced both of those by roughly 300 basis points or so over the last year.

In terms of stats and new and eliminated, again I'll just focus on a couple. On the new side, most of the longs have been addressed by other PMs and are held in other strategies. On the short side, core labs and campaign two energy names, both seem to be very poorly positioned for the current.

Energy Environment and Varian Medical is a new short in the portfolio.

This is a company that's focused on big-ticket radiation proton therapy equipment that seems to be addressing very saturated markets and there's some new technology, new competitors out there that we think could definitely pose some competitive challenges for the company going forward. So, initiated up a short position there.

In terms of eliminated positions, I'll just mention one quickly. Cummins was one we just put in the portfolio a couple quarters ago.

However, the thesis didn't seem to be materializing as their international business seemed to be a lot stronger than we anticipated offsetting some of the domestic pressures and so because of that, we turned around and eliminated the position just a couple quarters after initiating it. And finally, just net exposure, we usually mention this again.

Total gross is about 110% and net is about 54%, which is where the portfolio has been for the last couple quarters or so and I will there and happy to answer questions. Turn it back to Kristen..

Thanks Chris.

Finally, John Loesch will review our research opportunities and financial long-short fund, John?.

Thanks Kristen. The research opportunities fund Class I returned to 3.5% was ahead of the 3% return for the Russell 3000 as well as the 2.3% return of our blended benchmark and if you look over the trailing five years, we trailered the Russell 3, but are modestly ahead of the blended benchmark.

In the quarter in the long portfolio holdings and healthcare, discretionary and technology, provided large contribution to absolute return while industrial detracted and then in the short portfolio positions in consumer discretionary and technology for the primary detracted from return.

Looking at company returns more specifically, the holdings such as BioScript, Cognizant and Cincinnati Bell were the largest contributors. For BioScript, the new management team continues to execute on the recovery plan and the company terminated the majority of its contract of United Health, which was running at a negative margin.

Cognizant reported strong quarterly results that were consistent with the strategic plan that the management team released in February and then Cincinnati Bell recovered earlier declines since the company delivered steady first quarter results and maintained full-year guidance. Most of the detractors have been covered by other PMs.

Moving on to sector allocation, just a couple quick highlights. The year-over-year change in technology and telecom, the decline in technology is mainly related to exiting the investments in IBM and Apple in the last year and reallocating the proceeds to investments covered by our tech team like who has sacrificed locations by Russell are different.

And then the increase in telecommunications is primarily driven by our investment in Cincinnati Bell. So, in both cases, no major thematic drivers behind those changes. Next item is portfolio statistics, we ended the quarter with net exposure of 75%, which is in line with what we view is a long-term normalized position for the strategy.

This is below where we ended 2016 as we started trimming positions throughout the post-election rally that went early this year.

A lot of new eliminated positions most of which have been highlighted by others, I guess I will just call out the new positions for example, Bank of New York, which hasn’t been mentioned is one of the biggest REIT trust banks along with state REIT Northern Trust.

We believe the shares don't fully reflect the benefit of increasing interest rates, profit margin expansion and the firm's capital characteristics. And then the eliminated positions, Chris has mentioned the current position.

Tom has mentioned a --America and then the rest of them were primarily the three allocations to what we view as more attractive investments. So that's it for the research opportunities fund.

Next, I'll cover the financial long-short fund, which increased 2.6% during the quarter, compared to the 3.9% increase in the Russell 3000 Financials Index and the 3.2% increase in the blended benchmark.

Russell 3000 Financials Index lagged the broader index until the final week of the quarter when the Fed released the results of CCAR, which is the capital review that they do for the larger banks. There is annual regulatory evaluation, included better than extracted capital return for most firms.

These favorable CCAR outcome suggest regulatory release for the large financial institutions, which helped to offset the ongoing challenges from the macro environment during the quarter including low interest rates, tepid loan growth and flattening yield curve, some of which we've stated to see flow through to the banks that have already reported quarterly results.

And the largest industries in the financial index, banks, insurance and real estate, all posted low single digit returns for the quarter, while as mentioned earlier, consumer finance companies including the large credit card issuers were notably weak as investors focused on increasing credit cost.

Moving on to specific goals and performance, I'll just call out some that weren’t mentioned by others. Nationstar’s share rebounded nicely after selling off in the first quarter. No meaningful exchange in the thesis or fundamentals in the business year-to-date.

Colony NorthStar rallied in the first quarter following the closing of the three-party merger. The company's asset sales, fundraising and share buybacks were all ahead of expectations.

Then on detractors, let’s just call out Tanger, which is mostly been impacted by poor investor sentiments surrounding the retail industry as Tanger tents have been under pressure due to the shift to e-commerce. Moving on to industry exposures, I'll just highlight the decline in bank exposure and increased exposure to REITs.

We began turning bank exposures in the post-election rally as shares appeared to be discounting the potential positive of accelerating economic growth, accelerating loan growth, regulations, tax reform etcetera as if they're all certainties.

As it became evident that the political process is messy and will take time, Bankshares gave back some of their post-election gains and we've begun to selectively add back to some of what we trimmed earlier in the year.

Real estate REITs, which haven’t historically been a meaningful part of the strategy, peaked about this time last year including some of the bottoming of interest rates. Since that time, we've been selectively investing in some of the higher quality franchise as they’ve sold off as rates come up.

Look at some of the key portfolio statistics on the next slide. After peaking in October of last year at nearly 82%, our net exposure got back below 76 as we trimmed positions into the rally and it since began to drift back up as financials have sold off and in the quarter close to 79%.

There weren’t any new positions and as Tom mentioned earlier Fortress is part of an acquisition that should close in the back half of the year and then [indiscernible] estimate of intrinsic value. That wraps it up for the financial I am sure and I'll turn it back to Kristen..

Thanks John. That concludes our prepared remarks. Tilda, we're now ready to begin the question-and-answer segment of today's call..

[Operator instructions].

While we're waiting for questions to come in on the phone, we did receive a question online and we're going to direct this to Chuck. The question says, “I notice that all of the funds are underway energy, a sector that seems out-of-favor.

What is it about energy that makes it unattractive to your portfolio managers and specifically what about Cimarex Energy that makes it an attractive holding in your portfolio?”.

Yes, thanks Kristen. First regarding energy, the sector, it's interesting it's out-of-favor it was two of the best performing stocks in my portfolio last year were energy stocks.

So, it's out-of-favor, but out-of-favor relatively recently and the stocks began the year as I perceive to be relatively high valuation, discounting oil price levels which were difficult to maintain.

But to understand though the underweight, maybe it's best to go back in time to that period of time in 2004, 2005, 2006, when we were meaningfully overweight. At that point in time we saw worldwide supply-demand that was very tight.

Capital spending programs, which were just getting started were going to take multiple years to add meaningful new supply and worldwide demand growing nicely, a situation that was creating a difficult environment was solved only by rising energy prices that was held in market equilibrated.

These rising energy prices brought new capital spending online and slowed worldwide demand growth. Eventually those projects began to bring new supply on the market, which took place, excuse me, and spend but within the last five years or so especially in the United States and in oil shale.

So, what we had to contrast when we were heavily low in the portfolio and worldwide supply demand was tight and the secular outlook was for the tightness to remain.

Now we have worldwide supply-demand, which is -- we're in a world where there is meaningful excess supply, where right now OPEC is withholding supply from the market to try to tighten the market, but is having difficulty in doing so. And it's difficult to see a secular case where to tighten the market short of I guess extreme OPEC interference.

So, it's entirely a different situation than what we looked at a decade ago. The secular outlook is not particularly good and any meaningful increase in price only is meant by rising production from the world swing producers.

Meanwhile the stocks in my mind have not discounted the possibility of secularly lower oil prices and therefore, do not attractively valued.

Cimarex, the attractive Cimarex is its unique position in the US Permian Basin particularly, which allows it to grow production at relatively low oil prices and to be a winner if you will in a market where it's very difficult to win.

You want to own the companies with the premier assets of this environment, we feel Cimarex because of its unique position of domestic low-cost reserves with the opportunity to grow production is one of those companies that is uniquely positioned and therefore is attractively valued in a difficult industry and has owned broadly throughout the portfolios of various strategies at Diamond Hill..

Thanks Chuck.

Tilda, do we have any questions on the phone?.

We show no questions on the phone..

Okay. As a reminder for those of you who missed parts of the call or would like to listen to it again, we will post a replay on our website in a few days. Once again, thanks for joining us today and for your continued support of Diamond Hill. We look forward to speaking with you next quarter..

Thank you. Ladies and gentlemen, this concludes today's webinar. We thank you for participating. You may now disconnect..