On the surface, Austin Hawley seems to have little in common with his investment idol, Warren Buffett. At 42, he’s less than half the Oracle of Omaha’s age. Unlike Buffett, who invested in his first stock at age 11, Hawley had no idea what he wanted to do when he graduated from Dartmouth with a degree in history. “I wasn’t one of those people who started buying stocks when I was 10 years old,” he observes.
It wasn’t until he returned to Dartmouth for his MBA that he caught the Buffett bug from a professor, who was a big fan of the value-oriented, think-like-a-business-owner style.
For Hawley, who began co-managing the Diamond Hill Large Cap Fund two years ago with Chuck Bath, that style involves looking for companies trading at less than their intrinsic value, or the present value of future cash flows, over a five-year time horizon. In addition to being good values, the 40 to 60 stocks in the fund must have sustainable competitive advantages and conservative balance sheets. Once a stock reaches the estimate of intrinsic value and no longer sells at a discount, or a more attractive opportunity pops up, the team will sell it.
“We try to determine what a company will be worth in five years to a buyer,” Hawley says. “Growth is a key part of the value calculation, but we’re not willing to pay too much for it.”
Like Buffett, senior executives at Columbus, Ohio-based Diamond Hill Capital Management also believe in keeping a decent amount of skin in the game. To that end, Hawley and Bath each have more than $1 million invested in the fund. All told, the firm has $22 billion under management, with about half that in the large-cap strategy.
Although Morningstar classifies the $6.3 billion fund as large-cap value, the managers prefer companies with solid balance sheets and ample cash flows that have distinct quality growth overtones. This taste for “growthier” fare than what’s found in the typical value fund has helped put the Diamond Hill fund in the top quartile of its peers over the trailing three-, five- and 10-year periods.
The strict sell discipline has helped the managers put brakes on the fund in downturns. From its inception in 2001 through September 30, the fund’s downside capture ratio relative to the Russell 1000 Index was 94%, while it managed to ride 101% of the index’s upside. The Diamond Hill fund also has a reasonable 0.67% expense ratio and a low $2,500 minimum for I class shares.
Hawley says he’s well prepared to take the reins of the fund from the 63-year-old Bath (the latter has managed the fund since 2002). But such plans aren’t in the works at this point. “My coming on as co-manager is a clear succession plan,” he says. “But Chuck still loves what he does.”
Buying The Dip
To get favorable prices, Hawley and his team often zero in on stocks unfairly beaten up. Some of these stocks might enjoy quality and growth characteristics that help them thrive over the long term, but they’re currently stumbling because investors are ignoring them or overemphasizing bad news about them.
At 27% of assets, financials are by far the largest sector represented in the fund—which won’t dedicate more than 30% to any one sector or more than 7% to any one position. The financials position isn’t that unusual for a value offering. When the fund began adding to the sector in 2012, the emphasis was on large banks that sold at highly attractive valuations and stood to benefit from an expanding economy. More recently, the focus has shifted to a broader swath of financial sector industries, including property and casualty insurers.
One such company, American International Group (AIG), is a top 10 holding that was added to the portfolio at the end of 2018, a time when financial stocks were being particularly hard hit by a brutal market slide. Even though the fund had owned the property and casualty insurer before selling it in 2015, Hawley continued watching it for signs of fundamental improvement. Things began looking up in 2017, when Berkshire Hathaway entered into an agreement with AIG to take responsibility for some of its insurance claims if they exceeded a certain amount.
AIG has also built up its management team to include several respected property and casualty industry veterans, and the company boasts a global distribution platform that’s hard for competitors to replicate. By the time the stock re-entered Diamond Hill’s portfolio, it was selling at a discount to book value and an unusually attractive price-to-earnings multiple.