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Monday, June 1, 2015

Diamond Hill Dives Into 2nd Gen Passive Investing

Reported by Neil Anderson, Managing Editor

Ric Dillon just brought to life, in ETF form, a strategy that he first came up with more than 15 years ago in another life. And he's also bringing his current firm into the ETF space in the process.

Dillon took over what is now Diamond Hill Investment Group (DHIL) on May 12, 2000, and 15 years later to the day (on May 12, 2015), Diamond Hill Capital Management (DHIL's asset management arm) launched the Diamond Hill Valuation-Weighted 500 ETF, tracking Diamond Hill's own Diamond Hill Valuation-Weighted 500 index. The engine behind the fund is Diamond Hill's first ever ETF, a "passive with some active tinkering" fund in the words of national accounts director Craig Tann.

Dillon, CEO and PM at Columbus, Ohio-based Diamond Hill, calls the new fund a "second-generation passive investing" product. Though the rest of Diamond Hill's $16 billion in assets under management is all in active strategies, Dillon says that the new ETF draws on the same intrinsic valuation approach (rules-based, forward-looking, and incorporating mean-reversion of the capitalization rate and inclusion of the balance sheet) that Diamond Hill uses for all of its offerings. In the case of the ETF, Diamond Hill plugs into consensus estimates from outside stock analysts.

Diamond Hill first launched the strategy, in LP form, at the end of 2011, and last month they transformed that LP into an ETF. They're also going to be able to link the ETF's track record to that of the LP.

And the idea goes back even further than 2011. Dillon confirms that he first started a version of the strategy at another firm, in separate account form, in the late 1990s. At Diamond Hill he first focused on the active side, until creating this LP in 2011.

"We're the only product that's forward-looking in this space," Tann tells MFWire.

Though Dillon and his team aren't rushing to market with a second ETF just yet, he says he'll "consider others as time goes on." And he says he would also look at active, non-transparent ETFs if the regulatory environment changes.

As for this first ETF, Tann sees it "as a replacement for the SPYs [SSgA's giant S&P 500-tracking ETF] of the world." About 60-percent of Diamond Hill's distribution is through retail intermediaries like wirehouses and private banks, while just under 40 percent is institutional.

"We're also looking at it as a way to open the door to that segment of clients that has not talked to us in the past," like advisors who go all-passives or some pension plans, Tann says. "This proves to the market that we can build products in an SMA former for them. It also gives us a lot of different ways to communicate with clients that we haven't been able to communicate with in the past."

"There's a lot of good business reasons to do this," Dillon tells MFWire, noting that the ETF allows advisors and investors to see the stand-alone power of the tool behind Diamond Hill's strategies.

Down the line, to create other ETFs like this one, the Diamond Hill team would have to look to other indexes (like mid cap or global large cap ones) where consensus estimates from stock analysts are also available. 

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