Quarterly Commentary. December 31, Research Opportunities Fund. Select Fund

Transcription

1 Quarterly Commentary December 31, 2014 Small Cap Fund Small-Mid Cap Fund Mid Cap Fund Large Cap Fund Long-Short Fund Financial Long-Short Fund Research Opportunities Fund Strategic Income Fund Select Fund

2 Our Mission At Diamond Hill, we serve our clients by providing investment strategies that deliver lasting value through a shared commitment to our intrinsic value-based investment philosophy, long-term perspective, disciplined approach and alignment with our clients interests. VALUE We believe market price and intrinsic value are independent in the short-term but tend to converge over time. LONG-TERM We maintain a long-term focus both in investment analysis and management of our business. DISCIPLINE We invest with discipline to increase potential return and protect capital. PARTNERSHIP We align our interests with those of our clients through significant personal investment in our strategies. DIAMOND HILL IS A REGISTERED TRADEMARK OF DIAMOND HILL INVESTMENT GROUP, INC DIAMOND HILL CAPITAL MANAGEMENT, INC. ALL RIGHTS RESERVED

3 Diamond Hill 4th Quarter 2014 Market Review Driven by an expanding economy, growing corporate profits, and persistently low interest rates, the broad U.S. equity market posted its sixth consecutive annual gain in The S&P 500 Index finished the year with a 13.7% total return (including dividends), and the Federal Reserve signaled its belief in the economy s ability to grow without assistance by concluding its bond purchasing program known as Quantitative Easing, or QE, in October Although investors expect the Fed to raise interest rates sometime in 2015, its overall monetary policy remains accommodative, encouraging equity investors. In the U.S., unemployment fell as a result of the best hiring stretch since the late 1990s. The U.S. consumer benefitted from a steep decline in gasoline prices to the lowest levels in five years, adding more buying power beyond modest wage gains. The sharp decline in the price of oil over the past few months is likely to improve household budgets. Globally, central banks remained extraordinarily accommodative in an attempt to provide a backdrop for increased economic growth. Europe, which has been a clear economic laggard over the past few years, was still only showing modest signs of improvement. Meanwhile, China and India continued to grow at healthy mid-single digit rates, but many other emerging economies around the world are seeing decelerating growth rates. The U.S. dollar ended the year strong relative to other currencies as investors were confident that stronger economic growth in the U.S. will lead the Fed to raise rates in 2015 for the first time since before the financial crisis. Volatility May Simply Be Reverting To The Mean S&P 500 Annual Price Volatility (Annual High minus Low) as Pct Low Fourth Quarter Results The S&P 500 Index posted a 4.9% total return in the 2014 fourth quarter led by the utilities sector (+13%). Investors reacted to an unexpected decline in bond yields by seeking income in high dividend-yielding stocks like utilities. In contrast, the energy sector was the worst performing sector during the quarter (-11%) as oil prices plunged by nearly 50% in the second half of A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. Although the decline in the energy sector hurt our portfolio returns in 2014, the downside was mitigated by good stock selection. Most of our energy holdings have some of the strongest balance sheets in the industry along with some of the highest quality prospective inventories relative to the global industry. While we have reduced our estimates of intrinsic value, we believe these companies will manage this industry cycle very well and are positioned to emerge even stronger as the industry rebounds. As a result of their strong competitive positioning, many of our energy holdings declined less than the overall energy sector. Mitigating downside risk through good security selection is one of the benefits of active portfolio management. However, 2014 was a difficult year for active managers in large part due to lower volatility and lower dispersion. Dispersion Low Range of Monthly Returns of S&P 500 Stocks (Max-Min, 6M Avg) Source: Strategas Research Partners. Source: Strategas Research Partners. Note: Chart uses current S&P 500 Constituents DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 1

4 Diamond Hill 4th Quarter 2014 Market Review Volatility provides opportunities for active managers to identify mispricings in the market and take advantage of those mispricings. When volatility is low, there are fewer opportunities. Similarly, when dispersion is low, the spread between winners and losers is narrow, making it more difficult to stand out from the crowd. Market Outlook Despite the end of the Federal Reserve s Quantitative Easing, we continue to believe the Fed is likely to maintain a very accommodative overall monetary stance well into next year as the domestic economy is lacking signs of robust growth, while inflation expectations have again turned lower. The recent strength of the U.S. dollar is now playing a key role in these developments as its relative appreciation has created a new headwind for growth while also pushing down commodity prices. The modest deleveraging of the U.S. household sector over the past few years continues to be a positive story. These lower debt levels combined with very low interest rates have allowed consumer debt-service burdens to improve to very low levels by historical standards. This healthy debt service picture remains very much tied to historically low interest/mortgage rates, and any sharp, meaningful increase in those rates is likely to present an important headwind for growth. Although the U.S. economy appears to be healing at a steady pace and set to maintain its 2% - 3% growth heading into next year, we continue to expect positive but below average equity market returns over the next five years. Our conclusion is primarily based on above average price/earnings multiples applied to already very strong levels of corporate profit margins, which in combination, likely tempers prospective returns. This outlook also seems consistent with the current interest rate environment. We believe that we can achieve better than market returns over the next five years through active portfolio management and stock selection independent of benchmark weights. The views expressed are those of the portfolio managers as of December 31, 2014 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Portfolio holdings are subject to change and will be made available at least monthly for download at diamond-hill.com, typically on the seventh (7th) business day following the most recent month ending date. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 2

5 Diamond Hill Small Cap Fund Commentary The Fund increased 2.84% (Class I) during the quarter, compared to a 9.73% increase in the Russell 2000 Index. The Fund s holdings in the financials and consumer discretionary sectors provided the largest contributions to absolute return, while holdings in the energy sector detracted from return. The Fund s underperformance relative to the Russell 2000 Index was primarily the result of an overweight position in the energy sector, higher levels of cash, and security selection in the health care and industrials sectors. No exposure to the materials sector modestly contributed to relative return. Best Performers Shares of car rental company Avis Budget Group, Inc. increased after reporting solid third quarter profits on continued pricing increases and high utilization. Property and casualty insurance company Navigators Group, Inc. rose after reporting better than anticipated third quarter earnings, with continued double-digit premium growth and strong underwriting profitability. Personal care products and services provider Steiner Leisure Ltd. saw its stock price recover slightly in the fourth quarter, though it still experienced a negative return for the year. No major fundamental developments occurred. PORTFOLIO MANAGEMENT Tom Schindler, CFA Portfolio Manager As a result, oil and gas exploration and production companies Rosetta Resources, Inc., Whiting Petroleum Corp., Cimarex Energy Co. and Denbury Resources, Inc. all underperformed the broader market. Railroad service company Trinity Industries, Inc. declined, as the railcar segment is heavily influenced by demand for tank cars to transport oil. Weaker oil pricing puts this demand at risk. The company also suffered a setback in a large lawsuit. New Positions We did not initiate any new positions during the quarter. Eliminated Positions Chris Welch, CFA Asst. Portfolio Manager Jason Downey, CFA Asst. Portfolio Manager We completed the sale of transportation and logistics services provider XPO Logistics, Inc. Most of our shares were sold in the 2014 third quarter as the stock price approached our estimate of intrinsic value. Aircraft rental and leasing company Aircastle Ltd. rose after reporting strong third quarter earnings, as core leasing revenue increased and cash interest margins improved due to lower financing costs. The company also increased its quarterly dividend and announced a share repurchase authorization. Shares of healthcare products manufacturer Natus Medical, Inc. increased after announcing a modestly better than expected quarterly report. Worst Performers A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 3

6 Diamond Hill Small Cap Fund Commentary PERIOD AND AVERAGE ANNUAL TOTAL RETURNS AS OF DECEMBER 31, 2014 SINCE INCEPTION (12/29/00) 10-YR 5-YR 3-YR 1-YR YTD 4Q14 TOTAL EXPENSE RATIO RETURNS AT NAV (WITHOUT SALES CHARGE) Class A 11.63% 7.65% 13.50% 18.15% 4.60% 4.60% 2.78% 1.33% Class C Class I Class Y BENCHMARK Russell 2000 Index RETURNS AT POP (WITH SALES CHARGE) Class A Class C Risk Disclosure: There are specialized risks associated with small capitalization issues, such as market illiquidity and greater market volatility, than large capitalization issues. The views expressed are those of the portfolio managers as of December 31, 2014, are subject to change and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. It should not be assumed that an investment in the securities identified was or will be profitable. The holdings identified do not represent all of the securities purchased, sold, or recommended for the adviser s clients. The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. The Fund s current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days, at diamond-hill.com. Performance returns assume reinvestment of all distributions. Returns for periods less than one year are not annualized. Class C, Class I and Class Y shares include Class A share performance achieved prior to the creation of Class C, Class I and Class Y shares. These total return figures may reflect the waiver of a portion of a Fund s advisory or administrative fees for certain periods. Without such waiver of fees, the total returns would have been lower. The total return figures reflect the maximum sales charge applicable to each class. The maximum sales charge for A shares is 5.00%; C shares have a maximum contingent deferred sales charge (CDSC) of 1.00% for redemptions within the first year of purchase; I shares and Y shares have no sales charge. Fund holdings subject to change without notice. The Russell 2000 Index is an unmanaged market capitalization-weighted index comprised of the smallest 2,000 companies by market capitalization in the Russell 3000 Index, which is comprised of the 3,000 largest U.S. companies by total market capitalization. This index does not incur fees and expenses (which would lower the return) and is not available for direct investment. An investor should consider the Fund s investment objectives, risks, and charges and expenses carefully before investing or sending any money. This and other important information about the Fund(s) can be found in the Fund s(s) prospectus or summary prospectus which can be obtained at diamond-hill.com or by calling Please read the prospectus or summary prospectus carefully before investing. The Diamond Hill Funds are distributed by BHIL Distributors, Inc. (Member FINRA), an affiliated company. 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. Like all mutual funds, Diamond Hill Funds are not FDIC insured, may lose value, and have no bank guarantee. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 4

7 Diamond Hill Small Cap Fund Commentary MENTIONED SECURITIES AND RESPECTIVE WEIGHTS AS OF DECEMBER 31, 2014 Aircastle Ltd. 1.6% Rosetta Resources, Inc. 1.4% Avis Budget Group, Inc. 3.9 Steiner Leisure Ltd. 2.3 Cimarex Energy Co. 2.1 Trinity Industries, Inc. 1.6 Denbury Resources, Inc. 0.4 Whiting Petroleum Corp. 0.9 Natus Medical, Inc. 2.1 XPO Logistics, Inc. 0.0 Navigators Group, Inc. 2.8 To obtain the contribution calculation methodology and a complete list of every holding s contribution to the overall portfolio s performance during the measurement period, call or info@diamond-hill.com. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 5

8 Diamond Hill Small-Mid Cap Fund Commentary The Fund increased 6.17% (Class I) during the quarter, compared to a 6.77% increase in the Russell 2500 Index. PORTFOLIO MANAGEMENT The Fund s holdings in the consumer discretionary, financials, health care, and consumer staples sectors provided the largest contributions to absolute return. The energy sector was the primary detractor from return followed by the industrials sector. Chris Welch, CFA Portfolio Manager Tom Schindler, CFA Asst. Portfolio Manager Jenny Hubbard, CFA Asst. Portfolio Manager The Fund s underperformance relative to the Russell 2500 Index was primarily driven by an overweight position in the energy sector and security selection in the industrials sector. Security selection in the consumer discretionary sector provided the largest contribution to relative return followed by positive security selection in the energy sector. Best Performers Office products retailer Staples, Inc. rose on speculation of a possible merger with rival Office Depot after activist fund Starboard Value took a position in the company. Shares of household durables manufacturer Whirlpool Corp. increased as the company released good underlying results during the quarter, highlighted by continued domestic strength. Tire manufacturer Goodyear Tire & Rubber Co. rose after reporting a strong third quarter. With raw material prices remaining low and high-end tire prices and volumes remaining stable, the company was able to continue to build on the plan set in place by management earlier in the year. Insurance brokerage firm Willis Group Holdings PLC reported worse than anticipated third quarter earnings with organic revenue growth in the company s Global segment hurt by a soft reinsurance market and tough comparisons in the prior year period. However, expenses stabilized and the company appears poised to show meaningful margin improvement over the next several quarters. Personal care products and services provider Steiner Leisure Ltd. saw its stock price recover slightly in the fourth quarter, though it still experienced a negative return for the year. No major fundamental developments occurred. Worst Performers A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. As a result, oil and gas exploration and production companies Whiting Petroleum Corp., Cimarex Energy Co., and Noble Energy, Inc. all underperformed the broader market. Freight transportation management company Hub Group, Inc. declined after it reported weak third quarter earnings. The company also lowered guidance for the remainder of the year due to poor service levels from its rail partners, as well as a legal settlement with drayage drivers in California. We believe rail service levels should begin to improve in 2015 as railroads are currently making investments to add additional capacity. Diversified machinery manufacturer Dover Corp. declined due to the company s sizeable energy sector exposure which, given the recent decline in energy prices, will likely negatively impact operating performance in the near future. New Positions We initiated a position in financial holding company BOK Financial Corp., a high-quality, Oklahoma-based bank that we have followed for years. BOK Financial has a great franchise, and due to large insider ownership, its shares are infrequently available at an attractive discount to intrinsic value. The shares sold-off after oil prices declined reflecting BOK s larger-than-peer exposure to the energy sector. We believe the market was penalizing the shares more than justified and not respecting the company s multi-decade track record of sound underwriting in the energy sector. We DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 6

9 Diamond Hill Small-Mid Cap Fund Commentary initiated a position in pest control services company Rollins, Inc., one of the largest residential and commercial pest extermination businesses in the country. We view Rollins as a very high quality business run by a strong management team. During the broader market sell-off in October, the stock declined to a discount to our estimate of intrinsic value. The stock appreciated and quickly reached our estimate of intrinsic value in a short period of time, so we exited our position. We also initiated a position in Southwestern Energy Co. The shares declined on concerns around the announcement of a sizeable acquisition in the Marcellus shale and the lower natural gas price outlook for the next two years. This decline created an attractive discount to our estimate of intrinsic value. We believe Southwestern has made an attractive acquisition in one of the best natural gas assets in the country and is well positioned to supply low-cost natural gas as demand is expected to increase over the next decade. Eliminated Positions We sold our shares of bank holding company First Niagara Financial Group, Inc. as we lost confidence in company management due to a growing list of concerns, including poor third quarter results and an announcement of a large goodwill writedown for a previous acquisition. We eliminated our position in oil and gas exploration and production company Denbury Resources, Inc. as a result of what we believe to be structural changes in the competitive dynamics of the global oil industry and subsequent changes to our estimates of intrinsic value. A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. PERIOD AND AVERAGE ANNUAL TOTAL RETURNS AS OF DECEMBER 31, 2014 SINCE INCEPTION (12/30/05) 5-YR 3-YR 1-YR YTD 4Q14 TOTAL EXPENSE RATIO RETURNS AT NAV (WITHOUT SALES CHARGE) Class A 9.20% 15.55% 20.45% 7.17% 7.17% 6.16% 1.27% Class C Class I Class Y BENCHMARK Russell 2500 Index RETURNS AT POP (WITH SALES CHARGE) Class A Class C Risk Disclosure: There are specialized risks associated with small capitalization issues, such as market illiquidity and greater market volatility, than large capitalization issues. The views expressed are those of the portfolio managers as of December 31, 2014, are subject to change and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. It should not be assumed that an investment in the securities identified was or will be profitable. The holdings identified do not represent all of the securities purchased, sold, or recommended for the adviser s clients. The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. The Fund s current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days, at diamond-hill.com. Performance returns assume reinvestment of all distributions. Returns for periods less than one year are not annualized. Class Y shares include Class A share performance achieved prior to the creation of Class Y shares. These total return figures may reflect the waiver of a portion of a Fund s advisory or administrative fees for certain periods. Without such waiver of fees, the total returns would have been lower. The total return figures reflect the maximum sales charge applicable to each class. The maximum sales charge for A shares is 5.00%; C shares have a maximum contingent deferred sales charge (CDSC) of 1.00% for redemptions within the first year of purchase; I shares and Y shares have no sales charge. Fund holdings subject to change without notice. The Russell 2500 Index is an unmanaged market capitalization-weighted index comprised of the smallest 2,500 companies by market capitalization in the Russell 3000 Index, which is comprised of the 3,000 largest U.S. companies by total market capitalization. This index does not incur fees and expenses (which would lower the return) and is not available for direct investment. An investor should consider the Fund s investment objectives, risks, and charges and expenses carefully before investing or sending any money. This and other important information about the Fund(s) can be found in the Fund s(s) prospectus or summary prospectus which can be obtained at diamond-hill.com or by calling Please read the prospectus or summary prospectus carefully before investing. The Diamond Hill Funds are distributed by BHIL Distributors, Inc. (Member FINRA), an affiliated company. 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. Like all mutual funds, Diamond Hill Funds are not FDIC insured, may lose value, and have no bank guarantee. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 7

10 Diamond Hill Small-Mid Cap Fund Commentary MENTIONED SECURITIES AND RESPECTIVE WEIGHTS AS OF DECEMBER 31, 2014 BOK Financial Corp. 0.8% Rollins, Inc. 0.0% Cimarex Energy Co. 3.4 Southwestern Energy Co. 0.7 Denbury Resources, Inc. 0.0 Staples, Inc. 3.0 Dover Corp. 2.1 Steiner Leisure Ltd. 2.1 First Niagara Financial Group, Inc. 0.0 Whirlpool Corp. 1.9 Goodyear Tire & Rubber Co. 2.1 Whiting Petroleum Corp. 0.9 Hub Group, Inc. 3.2 Willis Group Holdings PLC 5.3 Noble Energy, Inc. 0.7 Mentioned securities not held in the Diamond Hill Small-Mid Cap Fund: Office Depot, Inc. To obtain the contribution calculation methodology and a complete list of every holding s contribution to the overall portfolio s performance during the measurement period, call or info@diamond-hill.com. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 8

11 Diamond Hill Mid Cap Fund Commentary The Fund increased 5.90% (Class I) during the quarter, compared to a 5.94% increase in the Russell Midcap Index. The Fund s holdings in the consumer discretionary, financials and health care sectors provided the largest contributions to absolute return. The energy sector was the primary detractor from return followed by the industrials sector. The Fund s underperformance relative to the Russell Midcap Index was primarily the result of an overweight position in the energy sector and security selection in the industrials sector. Security selection in the consumer discretionary sector provided the largest contribution to relative return. Best Performers Office products retailer Staples, Inc. rose on speculation of a possible merger with rival Office Depot after activist fund Starboard Value took a position in the company. Shares of household durables manufacturer Whirlpool Corp. increased as the company released good underlying results during the quarter, highlighted by continued domestic strength. Tire manufacturer Goodyear Tire & Rubber Co. rose after reporting a strong third quarter. With raw material prices remaining low and high-end tire prices and volumes remaining stable, the company was able to continue to build on the plan set in place by management earlier in the year. Medical device manufacturer Boston Scientific Corp. rose after the company reported strong third quarter results, showing continued signs of revenue acceleration and good execution on margin expansion goals. Insurance brokerage firm Willis Group Holdings PLC reported worse than anticipated third quarter earnings with organic revenue growth in the company s Global segment hurt by a soft reinsurance market and tough comparisons in the prior year period. However, expenses stabilized and the company appears poised to show meaningful margin improvement over the next several quarters. Worst Performers A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate PORTFOLIO MANAGEMENT Chris Welch, CFA Portfolio Manager anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. As a result, oil and gas exploration and production companies Whiting Petroleum Corp., Noble Energy, Inc., and Cimarex Energy Co. all underperformed the broader market. Diversified machinery manufacturer Dover Corp. declined due to the company s sizeable energy sector exposure which, given the recent decline in energy prices, will likely negatively impact operating performance in the near future. Shares of non-bank mortgage servicer Nationstar Mortgage Holdings, Inc. declined after one of its largest competitors announced a settlement with a regulatory body, sparking fear among investors of increased regulatory oversight of the non-bank mortgage servicing group. New Positions Chris Bingaman, CFA Asst. Portfolio Manager Jenny Hubbard, CFA Asst. Portfolio Manager We initiated a position in pest control services company Rollins, Inc., one of the largest residential and commercial pest extermination businesses in the country. We view Rollins as a very high quality business run by a strong management team. During the broader market sell-off in October, the stock declined to a discount to our estimate of intrinsic value. The stock appreciated and quickly reached our estimate of intrinsic value in a short period of time, so we exited our position. We initiated a position in specialty chemical company Eastman Chemical Co. when concerns about the company s Fibers business led to a decline in the shares which we believe provided an attractive entry point. The company continues to add higher margin, strong cash flow generating businesses to its portfolio, while the company is much less exposed to petrochemical earnings than its peers Dow Chemical Co. and LyondellBasell Industries N.V. We also initiated a position in financial holding company BOK Financial Corp., a high-quality, Oklahoma-based bank that we have followed for years. BOK Financial has a great franchise, and due to large insider DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 9

12 Diamond Hill Mid Cap Fund Commentary ownership, its shares are infrequently available at an attractive discount to intrinsic value. The shares sold-off after oil prices declined reflecting BOK s larger-than-peer exposure to the energy sector. We believe the market was penalizing the shares more than justified and not respecting the company s multi-decade track record of sound underwriting in the energy sector. Eliminated Positions We eliminated our position in specialty retailer Ross Stores, Inc. as the stock price reached our estimate of intrinsic value. We sold our shares of bank holding company First Niagara Financial Group, Inc. as we lost confidence in company management due to a growing list of concerns including poor third quarter results and an announcement of a large goodwill write-down for a previous acquisition. We eliminated our shares of Brink s Co. While the security services provider has had fundamental disappointments in recent years, the decision to eliminate the holding in the Mid Cap Fund was largely a function of the company s $1.1 billion market capitalization which is slightly below the Fund s definition of medium cap companies as well as for tax purposes. We sold our small position in communications equipment manufacturer Knowles Corp. for tax purposes. PERIOD AND AVERAGE ANNUAL TOTAL RETURNS AS OF DECEMBER 31, 2014 SINCE INCEPTION (12/31/13) 1-YR YTD 4Q14 TOTAL EXPENSE RATIO RETURNS AT NAV (WITHOUT SALES CHARGE) Class A 7.57% 7.57% 7.57% 5.77% 1.15% Class C Class I Class Y BENCHMARK Russell Midcap Index RETURNS AT POP (WITH SALES CHARGE) Class A Class C Risk Disclosure: There are specialized risks associated with small and mid capitalization issues, such as market illiquidity and greater market volatility, than large capitalization issues. The views expressed are those of the portfolio managers as of December 31, 2014, are subject to change and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. It should not be assumed that an investment in the securities identified was or will be profitable. The holdings identified do not represent all of the securities purchased, sold, or recommended for the adviser s clients. The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. The Fund s current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days, at diamond-hill.com. Performance returns assume reinvestment of all distributions. Returns for periods less than one year are not annualized. The total return figures reflect the maximum sales charge applicable to each class. The maximum sales charge for A shares is 5.00%; C shares have a maximum contingent deferred sales charge (CDSC) of 1.00% for redemptions within the first year of purchase; I shares and Y shares have no sales charge. Fund holdings, sector allocations, and portfolio statistics subject to change without notice. The Russell Midcap Index is an unmanaged market capitalization-weighted index measuring performance of the 800 smallest companies in the Russell 1000 Index. The Russell 1000 Index measures performance of the largest 1000 companies in the Russell 3000 Index. The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies by total market capitalization. This index does not incur fees and expenses (which would lower the return) and is not available for direct investment. An investor should consider the Fund s investment objectives, risks, and charges and expenses carefully before investing or sending any money. This and other important information about the Fund(s) can be found in the Fund s(s) prospectus or summary prospectus which can be obtained at diamond-hill.com or by calling Please read the prospectus or summary prospectus carefully before investing. The Diamond Hill Funds are distributed by BHIL Distributors, Inc. (Member FINRA), an affiliated company. 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. Like all mutual funds, Diamond Hill Funds are not FDIC insured, may lose value, and have no bank guarantee. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 10

13 Diamond Hill Mid Cap Fund Commentary MENTIONED SECURITIES AND RESPECTIVE WEIGHTS AS OF DECEMBER 31, 2014 BOK Financial Corp. 0.8% Nationstar Mortgage Holdings, Inc. 1.0% Boston Scientific Corp. 4.2 Noble Energy, Inc. 1.6 Brink's Co. 0.0 Rollins, Inc. 0.0 Cimarex Energy Co. 3.5 Ross Stores, Inc. 0.0 Dover Corp. 2.4 Staples, Inc. 2.4 Eastman Chemical Co. 0.7 Whirlpool Corp. 2.5 First Niagara Financial Group, Inc. 0.0 Whiting Petroleum Corp. 0.9 Goodyear Tire & Rubber Co. 2.1 Willis Group Holdings PLC 5.3 Knowles Corp. 0.0 Mentioned securities not held in the Diamond Hill Mid Cap Fund: Dow Chemical Co., LyondellBasell Industries N.V., Office Depot, Inc. To obtain the contribution calculation methodology and a complete list of every holding s contribution to the overall portfolio s performance during the measurement period, call or info@diamond-hill.com. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 11

14 Diamond Hill Large Cap Fund Commentary The Fund increased 5.65% (Class I) during the quarter, compared to a 4.88% increase in the Russell 1000 Index. The Fund s holdings in the consumer discretionary, health care, financials, and industrials sectors provided the largest contributions to absolute return, while holdings in the energy sector detracted from return. The Fund s outperformance relative to the Russell 1000 Index was driven primarily by security selection in the consumer discretionary and health care sectors. Security selection in the information technology sector and an overweight position in the energy sector detracted from relative return. Best Performers Medical device manufacturer Medtronic, Inc. rose after the company reported strong quarterly results, showing revenue growth and improving sales trends across its businesses. The company also announced that it would proceed with its planned merger with Covidien PLC, which will be the largest in the history of medical technology. Shares of household durables manufacturer Whirlpool Corp. increased as the company released good underlying results during the quarter, highlighted by continued domestic strength. Tire manufacturer Goodyear Tire & Rubber Co. rose after reporting a strong third quarter. With raw material prices remaining low and high-end tire prices and volumes remaining stable, the company was able to continue to build on the plan set in place by management earlier in the year. Investment brokerage firm Morgan Stanley reported another quarter of relatively strong core results. The company benefited from strong equity markets and continued improvement in operating margins. In particular, the company has meaningfully increased margins in its very important Wealth Management segment and remains optimistic this trend will continue in coming quarters. Discount apparel retailer TJX Cos., Inc. rose after reporting solid third quarter results, spurred by indications that it continues to take share from Kohl s Corp. and other mid-tier department stores. PORTFOLIO MANAGEMENT Chuck Bath, CFA Portfolio Manager Worst Performers A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. As a result, oil and gas exploration and production companies Cimarex Energy Co., Noble Energy, Inc., Devon Energy Corp., and Occidental Petroleum Corp. all underperformed the broader market. Diversified information technology company International Business Machines Corp. declined after the company reported disappointing third quarter earnings and management indicated that it would fail to meet the 2015 earnings guidance detailed in the company s much-publicized 2015 Roadmap. New Positions Chris Welch, CFA Asst. Portfolio Manager Rick Snowdon, CFA Asst. Portfolio Manager We initiated new positions in two companies. Credit services company Capital One Financial Corp. is one of the most recognized brands in financial services and the 8th largest bank in the U.S. The firm has national scale as a top five credit card and auto lender and a significant traditional branch banking presence with commercial lending capabilities in a number of large U.S. markets. We expect Capital One s core credit card and auto loan segment to experience continued loan growth as a function of an improving economy, an improving job market and increasing confidence in consumer spending decisions. Capital One also benefits from the continuing shift in favor of electronic payments (i.e. ApplePay) versus cash and check. We believe Capital One will continue to generate healthy returns in a business model that is capital generative and the market will reward Capital One for its earnings power and its management s new focus on returning DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 12

15 Diamond Hill Large Cap Fund Commentary capital to shareholders versus acquisitions. We also initiated a position in specialty chemical company Eastman Chemical Co. when concerns about the company s Fibers business led to a decline in the shares which we believe provided an attractive entry point. The company continues to add higher margin, strong cash flow generating businesses to its portfolio, while the company is much less exposed to petrochemical earnings than its peers Dow Chemical Co. and LyondellBasell Industries N.V. We received shares of California Resources Corp. as a distribution in-kind from our holding of Occidental Petroleum Corp. and shares of Halyard Health, Inc. from a spin-off from our Kimberly-Clark Corp. position; we sold both distributions. opportunities. PepsiCo shares were very close to our estimate of intrinsic value at the time of sale. We eliminated our position in oil and gas exploration and production company Noble Energy, Inc. as a result of what we believe to be structural changes in the competitive dynamics of the global oil industry and subsequent change to our estimate of intrinsic value. A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. Eliminated Positions We eliminated our shares of consumer snack & beverage manufacturer PepsiCo, Inc. during the fourth quarter market sell-off to provide funds for more attractive investment PERIOD AND AVERAGE ANNUAL TOTAL RETURNS AS OF DECEMBER 31, 2014 SINCE INCEPTION (6/29/01) 10-YR 5-YR 3-YR 1-YR YTD 4Q14 TOTAL EXPENSE RATIO RETURNS AT NAV (WITHOUT SALES CHARGE) Class A 8.25% 8.63% 13.59% 19.12% 10.42% 10.42% 5.56% 1.05% Class C Class I Class Y BENCHMARK Russell 1000 Index RETURNS AT POP (WITH SALES CHARGE) Class A Class C Risk Disclosure: Overall equity market risks may affect the value of the fund. The views expressed are those of the portfolio managers as of December 31, 2014, are subject to change and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. It should not be assumed that an investment in the securities identified was or will be profitable. The holdings identified do not represent all of the securities purchased, sold, or recommended for the adviser s clients. The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. The Fund s current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days, at diamond-hill.com. Performance returns assume reinvestment of all distributions. Returns for periods less than one year are not annualized. Class C, Class I and Class Y shares include Class A share performance achieved prior to the creation of Class C, Class I shares and Class Y shares. These total return figures may reflect the waiver of a portion of a Fund s advisory or administrative fees for certain periods. Without such waiver of fees, the total returns would have been lower. The total return figures reflect the maximum sales charge applicable to each class. The maximum sales charge for A shares is 5.00%; C shares have a maximum contingent deferred sales charge (CDSC) of 1.00% for redemptions within the first year of purchase; I shares and Y shares have no sales charge. Fund holdings subject to change without notice. The Russell 1000 Index is an unmanaged market capitalization-weighted index comprised of the largest 1,000 companies by market capitalization in the Russell 3000 Index, which is comprised of the 3,000 largest U.S. companies by total market capitalization. This index does not incur fees and expenses (which would lower the return) and is not available for direct investment. An investor should consider the Fund s investment objectives, risks, and charges and expenses carefully before investing or sending any money. This and other important information about the Fund(s) can be found in the Fund s(s) prospectus or summary prospectus which can be obtained at diamond-hill.com or by calling Please read the prospectus or summary prospectus carefully before investing. The Diamond Hill Funds are distributed by BHIL Distributors, Inc. (Member FINRA), an affiliated company. 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. Like all mutual funds, Diamond Hill Funds are not FDIC insured, may lose value, and have no bank guarantee. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 13

16 Diamond Hill Large Cap Fund Commentary MENTIONED SECURITIES AND RESPECTIVE WEIGHTS AS OF DECEMBER 31, 2014 California Resources Corp. 0.0% Kimberly-Clark Corp. 2.2% Capital One Financial Corp. 2.0 Medtronic, Inc. 2.9 Cimarex Energy Co. 1.9 Morgan Stanley 3.1 Devon Energy Corp. 3.0 Noble Energy, Inc. 0.0 Eastman Chemical Co. 1.0 Occidental Petroleum Corp. 1.5 Goodyear Tire & Rubber Co. 1.3 PepsiCo, Inc. 0.0 Halyard Health, Inc. 0.0 TJX Cos., Inc. 2.3 International Business Machines Corp. 1.6 Whirlpool Corp. 1.7 Mentioned securities not held in the Diamond Hill Large Cap Fund: Covidien PLC, Dow Chemical Co., Kohl s Corp., LyondellBasell Industries N.V. To obtain the contribution calculation methodology and a complete list of every holding s contribution to the overall portfolio s performance during the measurement period, call or info@diamond-hill.com. DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 14

17 Diamond Hill Select Fund Commentary The Fund increased 6.17% (Class I) during the quarter, compared to a 5.24% increase in the Russell 3000 Index. The Fund s holdings in the consumer discretionary, financials, and health care sectors provided the largest contributions to absolute return, while holdings in the energy sector detracted from return. The Fund s outperformance relative to the Russell 3000 Index was primarily the result of security selection in the consumer discretionary sector, while security selection in the information technology and industrials sectors detracted from relative return. Best Performers Shares of household durables manufacturer Whirlpool Corp. increased as the company released good underlying results during the quarter highlighted by continued domestic strength. Consumer products manufacturer Jarden Corp. rose after it released strong third quarter results highlighted by solid organic growth, driven by the Branded Consumables and Consumer Solutions divisions, and continued margin expansion. Food products company Post Holdings, Inc. rose sharply during the quarter after the company assured investors that recent business disruptions were temporary in nature. Insurance brokerage firm Willis Group Holdings PLC reported worse than anticipated third quarter earnings with organic revenue growth in the company s Global segment hurt by a soft reinsurance market and tough comparisons in the prior year period. However, expenses stabilized and the company appears poised to show meaningful margin improvement over the next several quarters. Medical device manufacturer Boston Scientific Corp. rose after the company reported strong third quarter results, showing continued signs of revenue acceleration and good execution on margin expansion goals. Worst Performers Diversified information technology company International Business Machines Corp. declined after the company reported disappointing third quarter earnings and management indicated PORTFOLIO MANAGEMENT Austin Hawley, CFA Portfolio Manager that it would fail to meet the 2015 earnings guidance detailed in the company s much-publicized 2015 Roadmap. A combination of domestic oil production growth, an increase in the supply of oil from Libya, weakening demand trends in Europe and Asia, and OPEC s unwillingness to reduce output to mitigate anticipated over-supply led to a significant decline in oil prices as well as a decline in the oil price outlook over the next few years. As a result, oil and gas exploration and production companies Cimarex Energy Co. and EOG Resources, Inc. underperformed the broader market. Freight transportation management company Hub Group, Inc. declined after it reported weak third quarter earnings. The company also lowered guidance for the remainder of the year due to poor service levels from its rail partners, as well as a legal settlement with drayage drivers in California. We believe rail service levels should begin to improve in 2015 as railroads are currently making investments to add additional capacity. Diagnostic systems provider Alere, Inc. declined after installing a new CEO during the quarter, while weathering an unsolicited attempt by the previous CEO to take the company private. Subsequently, the company announced that it would sell its Health Management business in a first sign of the implementation of a new agenda focused on asset sales and debt paydown. New Positions Rick Snowdon, CFA Portfolio Manager We took advantage of the stock market s over-reaction to food products company Post Holdings, Inc. s weak quarterly results to initiate a position in the Fund. We also initiated a position in Vantiv, Inc. as the company s shares traded lower after a mild third quarter disappointment in the financial institution segment of its business. The shares then rebounded during the fourth quarter as investors focused on the long-term growth story and attractive DIAMOND HILL CAPITAL MANAGEMENT, INC. QUARTERLY COMMENTARY DECEBMER 31, 2014 DIAMOND-HILL.COM 15