DIAMOND HILL LONG/SHORT INTERVIEW
January 3, 2006
We are going to ask you a
basic question. Who is Diamond Hill? It looks like you are a
load fund group, and it does not look like you do much marketing
except through the broker-dealer community.
Ric Dillon: Yes, we are relatively young. We
just completed our fifth calendar year with most of our
strategies. The company came out of a different business, a
different company, and that history is neither particularly
interesting nor pertinent. I joined the company in May of 2000
to build what is known as Diamond Hill. My background is in the
investment management business, having been with Loomis Sayles
and having my own firm, as well as a few other jobs over the
last 29 years. My colleagues who joined me here are people that
I had either worked with in the past and/or people I knew very
well over the last couple dozen years. We put this together and
offered the different strategies that I and others have been
involved with over our careers. The fund that started it all was
actually from the previous business. It is our bank and
financial fund which goes back to 1997 with the former company,
then known as the Bank Stock Group. None of those people are
here now, but they started that fund. It was a load fund because
they were a broker-dealer. As we started our new fund, it came
out of that same registered investment company and was a load
fund. However, the vast majority of the money invested in our
funds has come from RIAs on a no-load basis. Very little of our
business has been with any kind of sales charge. I think most of
it has come through the big platforms that everyone knows, such
as Schwab, Fidelity and TD Waterhouse.
Those fund platforms are the ones that seem to be the three
groups which represent a high percentage of our business,
perhaps as much as 70%. Again, as Iíve mentioned, my
background goes back to 1977. Our managing director of equity is
Chuck Bath, someone Iíve known since he came into the
investment business. He originally was a CPA, then received his
MBA and entered into this business in 1982. Our other three
equity decision-makers are people who either worked with me
and/or Chuck previously. Thomas Schindler co-manages the small
cap and Christopher Bingaman co-manages our new small mid-cap
fund with Christopher Welch. Tom and Chris Bingaman worked with
me at first, and then went to work with Chris Welch and Chuck at
Nationwide. Now we are all together here at Diamond Hill.
In terms of your
organizational structure and making decisions, how many analysts
do you have working with you?
Ric Dillon: We have five equity
decision-makers, PMs (Portfolio Managers) if you will, and a
couple of younger fellows, Bhavik Kothari and Jason Downey, who
are analysts who do not have investment decision-making ability
but certainly work in support roles for what the five of us do.
While we work as a team, we have different strategies and
individual responsibilities for each of us. In all strategies we
function as a team, with a lot of communication and
collaboration, but ultimately we have de-centralized
So the decisions are made
as a whole? In other words, is it a voting system?
Ric Dillon: No, not at all. For instance, say
that Chris Bingaman decides he likes Wells Fargo. Wherever it is
appropriate, Wells Fargo will go into the portfolio. Chuck Bath,
who is the managing director of equity, is the
"captain" of the team, while also is the manager of
Large Cap. On the Long/Short Fund and New Select Fund he is the
co-manager, and yet he has been involved with some small cap
names where he is the primary analyst. We could go on and on
with these kinds of examples illustrating that, while we
function as a team, we have individual responsibilities and work
in that fashion.
Have all the
decision-makers been with the firm since the inception of the
Ric Dillon: No, I was the first, followed
shortly thereafter by Tom Schindler and Chris Bingaman, then
Chuck Bath and, most recently, Chris Welch.
If something were to
happen to you Ric, who would take over the Small Cap and
Ric Dillon: Tom is already the co-manager of
the Small Cap Fund, but I do not know that I have a good answer.
I guess it depends on when this would happen. If it were today,
maybe it would be Chris Bingaman. If it were four years from
today, maybe we would not necessarily assign anybody to it with
Tom, and he would just become the sole manager. I guess it would
depend on the circumstances. We have toyed with the idea of
calling all of them team-managed, but we have not done that and
probably will not do that. That at least expresses a sentiment
of how we look at ourselves truly working as a team. For
instance, every day at ten oíclock we meet and discuss ideas
regarding the Large Cap, Small Cap, Long/Short Funds or anything
How many total funds are
there for Diamond Hill on the public side and on the private
side? Are you running any private money?
Ric Dillon: Yes, we have started two new
funds, bringing the total now to seven mutual funds. Five funds
you could find information on, and the two new funds started on
December 30, 2005. The five mutual funds then would be our Large
Cap and our Small Cap, our Long/Short, the original bank fund
which is called the Bank and Financial Fund, and then a fixed
income fund called Strategic Income. The first new funds would
be a Small-Mid Fund, because we closed our small fund, and the
new fund does not include any of the small cap stocks under $500
million and then goes up into the mid category. The second new
fund is what we call Select, which is our fund for our favorite
ideas, again with a $500 million minimum market cap so that it
does not encroach on the capacity of the micro-cap portion of
the Small Cap Fund. Select is a strategy for which we had
separate accounts for more than five years. It is actually our
original strategy which we started in 2000, five and a half
years ago. We are just making it into a mutual fund as well, but
most of our separate account assets are in that strategy. It is
a concentrated strategy and, as I said, It is an all cap
How much money do you
have in separate accounts?
Ric Dillon: Separate accounts would total
about $500 million, $900 million in mutual funds, and another
$100 million in a private investment partnership. So $1.5
billion would have been the December 31, 2005 assets under our
We have Morningstar
reports for the Focus Long/Short Fund and the Small Cap Fund. It
seems like you have had a tremendous run-up in assets this year.
Ric Dillon: Yes, at the end of 2004 we
finished the year around $524 million total. Of course, this
year there was appreciation, but the vast majority was new
What do you attribute
Ric Dillon: On the small cap side, people with
good small cap records, a number of the funds closed. Ours was
one of the few that was still open and had an excellent record.
That drove a lot of assets, approximately $300 million in new
assets, to the Small Cap Fund. That is why we closed it. As for
our long/short strategy, in addition to a good record, there are
not many long/short mutual funds out there, especially with good
track records. Probably $250 million came into that fund. Our
Large Cap Fund also has an excellent record. When Chuck Bath
joined us, Morningstar said that he was one of the best large
cap managers in the United States for the past two decades, and
yet he joined our little firm. I think that is starting to get
some traction in our large cap strategy.
Ric, you had mentioned
that the separate accounts were managed in one style. What style
Ric Dillon: I said that most of them would
have been in our Select Strategy. We had formerly called it our
All Cap Concentrated Strategy, but that was a little wordy so
when we started the mutual fund version, we decided to just call
it the Select Fund. It is our favorite ideas from large cap and
small cap with the caveat that we do not buy names under $500
million, because we do not want to encroach on the micro-cap end
of our small cap capacity. So it is an all cap fund with the
exception of the sub-$500 million portion of the Stock Market.
Did you start the
institutional funds at the same time as the A shares?
Ric Dillon: No, those were started in 2005.
dates back to January 1, 2001.
Ric Dillon: I think they do that, but the
asset class did not exist. They take the A shares and they
adjust for lack of the load and the lower expense ratio. The
other thing I know they do now, which just started last month,
is that on the A shares they now give their star ratings, both
with and without the load. Almost all of ours sold are load
You mentioned that the
Small Cap Fund was currently under a soft close. Do you
anticipate that going to a hard close?
Ric Dillon: Probably not in 2006. Whether it
will ever happen, I do not know. We originally thought $500
million in total assets was the number that we could handle, and
when we got to $350 million we decided to do the soft close
earlier rather than doing a hard close at all. I am hoping that
we can avoid doing the hard close forever, but I canít really
So you do not have a set
asset range at which to close?
Ric Dillon: When people started asking the
question two years ago, we said $500 million was what we thought
we could manage, not drawing a distinction between hard and soft
because back then we did not have that much. As we got closer to
that number, we decided to start thinking about this issue
pretty seriously. We chose to do a soft close far in advance of
reaching $500 million so we would not have to cut off our
business relationships. We understood that over time that number
would be met at a certain point and grow higher. My guess is we
did the soft close early enough that we will not have to do a
hard close in 2006, and hopefully wonít ever have to do one.
But it is hard to say because you get into some of these 401(k)
plans and you just do not know what is going to happen.
Could some of that new
money been attracted by the 50% return in 2003?
Ric Dillon: Yes, 2003 was a good year for
small cap and we participated fully. I think the Russell was up
nearly 40%. It was a big year all the way across, but yes, the
50% return was way above average so I am sure that helped a lot.
Is there anything special
that you can point to that helped your performance?
Ric Dillon: In 2003, and it seems like it is
always this way, there were just a few holdings that drove our
results. We had a couple of big winners, actually a couple of
holdings where Chuck Bath was the analyst, Pacificare and
Greenbriar. Everything was up in 2003, but those two were up
200% to 300%. Since we run relatively concentrated portfolios,
they were both 2% or 3% positions at the beginning of the year.
When you have that kind of performance on positions that size,
you can add five to ten percentage points to the return. In
2005, the markets were not that good and neither was our fund,
but again if you look at the oil stocks that we had you would
see that they did especially well last year, as well as the
airline stocks. Brinks was also a big winner for us last year.
Probably the top five performers were responsible for 60% to 70%
of the performance.
Do you have any foreign
exposure in your Small Cap Fund?
Ric Dillon: Not probably in the sense that you
mean the question. We do not have ADRs or off-shore companies.
Even some of our small cap names have international business,
but I assume that is not what you meant.
Ric Dillon: Again, with that caveat in mind,
we really do not manage non-U.S. or purchase non-U.S. companies.
There is the occasional exception once every three years where
we might have a small position in an ADR, but it is close enough
to zero to think of it as zero.
We would like to shift
the focus to more of a broad view on what you expect from the
markets, what sectors you think are performing better now, and
what you expect from them going forward.
Ric Dillon: We are very long-term investors,
and probably a lot of people make that claim, but our annual
turnover is 20% to 30% or less. The reason I start with that is
because five years ago we had a big emphasis in the small cap
area, so in our Select strategy where most of our separate
account business is, and even in our large cap where we used the
Russell 1000 instead of the S&P 500, if you look at the
holdings five years ago or four years ago they tended to be more
on the lower end of that. We had this view that the attractive
valuations were at the small end and so those were the companies
we wanted to own. In the first three of the past five years,
that is what we did. Fortunately, that worked out very well. The
theme of the past two years might be called inflation-sensitive
or commodity-related, since energy in particular would fit into
that theme. For the last two years, commodity or
inflation-sensitive, including some transportation/industrial,
might represent half of our portfolios. That was last year. As
we enter 2006, we have the same emphasis and the same strong
conviction. Chuck was talking about a conversation he had with
someone just the other day, and he told them that this could be
a theme for a very long period of time. We do not know, of
course, because it depends partly on how the stocks do. If
tomorrow we woke up and they all doubled, we would sell them and
move to something else, but that probably is not going to
happen. Most likely it just sort of develops and evolves and we
continue to have that emphasis into 2006, maybe 2007 or 2008. It
is hard to say. We are always asking what the fundamentals are
and what those fundamentals are worth. For instance, the
fundamentals in energy are still especially attractive to us.
Those fundamentals are causing growth in worldwide demand,
difficulty in meeting that worldwide demand from existing
supply, and new finds having a hard time off-setting supply
declines. Then you ask what is that worth, what are the
valuations? When we look at the valuations in the companies,
they are still very compelling. It is the only area, generally,
where we are seeing expected returns over the next five years in
the double digits. Almost every other sector has expected
returns in the single digits, some cases high single digits,
some cases low single digits. That is why we have the emphasis
in our long strategies or alongside our long/short strategies on
the inflation-sensitive, commodity-related areas, energy in
What kind of system do
you have in place for selecting candidates for your portfolio?
Do you run models and then generate buy signals off those?
Ric Dillon: We do have a valuation model that
is proprietary, and you can read about it on our website. But I
always like to emphasize that it is just a tool and a framework
to think about things because it is forward-looking and
therefore requires judgment input. While we have first
approximations on over 3,000 companies, we never evaluate them
solely based on those first approximations. What we have to do
is to go into each companyís valuation model and ask what do
we think about it, make judgments and estimates, and then those
result in valuations that we take into consideration. After that
is done, it is pretty easy to say that a stock looks like it is
worth ten dollars and is selling at seven, so it is a good buy.
Or that this stock is worth ten and is selling at fifteen, so
that is not an attractive stock. But the tough part is the
fundamentals that go into determining that "ten" in
Can you tell us about any
hedging strategies that you are using on any of your funds?
Ric Dillon: Yes, we do have the Long/Short
Fund, and when people see "long/short" they call it a
hedge fund. I say it that way because we do not think of it that
way at all, and that is important. A lot of people will not want
to invest in our long/short strategy after they hear how we do
it. We are not market-neutral, and we likely never will be
market-neutral. We are not even sector-neutral. For instance,
currently we do not have any shorts on the energy side. We are
long with things we think can make money on the long side, and
we are short the things we think can make money on the short
side. It is probably a rare occurrence, where you would have
long and short in the same industry when that is what you are
trying to do. We are not trying to minimize volatility like many
long/short strategies, we are trying to maximize return. Yes, we
have less volatility than our long-only strategies, and
naturally that is going to normally be the case, but that is not
what we are trying to do. We are really just trying to make
money, and so we realize we are not going to appeal to everybody
with that kind of approach to a long/short strategy, having a
long bias and not approaching anything close to
sector-neutrality or hedging.
We believe in long/short
like you do. Many people look at market-neutral and long/short
as being the same strategy. We do not! On the other hand, if you
are long-biased, what happens if you view there is nothing to
buy on the value side of the ledger? Would you go more short
Ric Dillon: No, we want to have a range of 30%
to 70% net long. I do not know what we would do if we could not
find anything. That is a great question, but I do not have an
Where would you be in
January of 2000?
Ric Dillon: Our long/short partnership started
in December of 2000. That was our first long/short strategy. We
had no problems finding small cap names and we had no problems
finding stocks to short, which tended to be mega-cap names and
tech names. For instance, in our long/short partnership, and
again the mutual fund was long-only back then, the years 2001
and 2002 were especially good on the short side, so we made
money both years. This would be a tougher time because, with the
exception of energy, it is awfully tough to find, in our view,
attractive long positions. One of the things that happens is our
total invested position tends to be lower, because if you want
to have that net long I described and you have limitations on
how much you can short, the result is you are going to have less
on the long side. We might be 80% long and 35% short for a net
45 today, whereas back then, had the mutual fund been
long/short, we could have been 100% on the long side and 40% on
the short side because we were so positive about small cap and
yet so negative about other things, the dichotomy could not have
been greater. Well, it is not like that now, and it is harder to
have that kind of conviction. The only place on the long side,
as I have said a few times now, is in energy where we have that
kind of conviction.
Your asset levels do not
seem to be a problem in terms of performance. In terms of the
Long/Short Fund, is there an upper limit that you would put on
shorts such as 20% to 30% of the total 100% of assets?
Ric Dillon: The mutual fund actually, by
prospectus, limits it to 40%. So 40% is the most we would have
on the short side.
When you go out five
years, according to Morningstar, your standard deviation is much
higher for the Long/Short Fund at 17, whereas over the last
three years it has been closer to nine.
Ric Dillon: For the first couple years it was
long only, so that is the reason. We changed it a couple years
ago to a long/short fund, mainly because as a new firm we were
not getting any traction. No one cared about it so we said, this
is not working. Our Long/Short Partnership had performed well.
We decided to change the fund into a long/short mutual fund
because there did not seem to be many of those. There seemed to
be less competition there than in the long-only mutual fund
world. It was a business decision to go long/short. Now that we
have more traction, we are going back to the Select fund idea.
We hope to be a little more successful from a business
perspective this time around.
In terms of the
Long/Short Fund, do you know exactly when you went to long/short
strategy on that fund?
Ric Dillon: We got permission in mid-2002, and
by the end of the year were fully invested, so from 2003 through
2005 we would have been running it as a long/short fund. That is
why those statistics would show up as they do.
From the standpoint of
that particular fund and also the long/short partnership, prior
to the Partnership, who had experience on your management team
Ric Dillon: I had run long/short money as a
fund prior to coming here. The other folks here, while they had
not done it on a fund, had all done it personally. To be clear,
the partnership was long/short from its inception in December of
2000. If you were to look at the partnership in the first couple
of years, its results were very different from the mutual fund
because it was long-only. Then in 2003 you will see a conversion
and the results were very similar to 2003, 2004, and 2005.
Is there anything
different about the partnership?
Ric Dillon: Yes, it uses leverage. While the
positions will be the same and the net long position will be the
same, the total exposure is very different. If the mutual fund
is 80% long and 35% short, which is a total of 115% invested but
net 45%, the partnership might be 110% and 65%, which is the
same net 45%, but total exposure is 175%. So you will notice a
tremendous amount of difference in terms of the investment
exposure. If things are going really well for us, the
partnership should do much better, or if things are going really
badly for us, the partnership will do much worse because of that
total exposure being roughly 50% on average greater than the
From the standpoint of
the partnership itself, what kind of minimums are there?
Ric Dillon: $1 million.
In looking at the top
holdings in your Long/Short and Small Cap Funds, there is
something called a Diamond Hill Short Term. Is that just a cash
Ric Dillon: Yes, a cash substitute. The Small
Cap Fund finished the six months on June 30th and the
twelve months on December 31st with almost 30% cash,
so of course you find all kinds of vehicles to put it in.
Is the First American
holding also a cash alternative? You have a pretty heavy
Ric Dillon: Yes. We have a half dozen
different investments that are all cash, so you can see equity
would be at 70% and anything below is cash.
Can you distinguish the
long-only strategy within the Long/Short Fund and any
similarities that it has with the small cap piece? Are they
roughly the same, based on the same types of models, or do you
do things differently?
Ric Dillon: No, they have the same valuation
framework. In fact, if you were to dig out the holdings from two
or three years ago, you would find a tremendous amount of
overlap. Today you will not find much overlap because so many of
those small cap names have done so well that we have not left
them in the long-only part, which is the Select part of our
Long/Short strategy. Just to clarify, our new Select Fund has
the same holdings as the long side of our Long/Short Fund. That
long piece of Long/Short Fund is our Select, or our All Cap
Concentrated, or whatever you want to call it. A few years ago,
it was dominated by small cap names while today it is dominated
by mid- to large-cap names.
We see from the yearly
returns that the Small Cap Fund had a 25% return approximately
in 2001, whereas the Long/Short Fund returned 6.11%. Were not
these time periods prior to the Long/Short Fundís ability to
Ric Dillon: Yes, clearly the Small Cap Mutual
Fund had a great 2001. I guess what one might say is that some
of the biggest winners in the Small Cap Fund were either not
represented, so we missed them, or not represented enough in the
fund. In 2001, by the way, I think it was a pretty good year for
the Russell 2000 value. Some of the names that would have been
represented there we just did not have in our All Cap
Concentrated. The 6% seems a little low, I would have thought it
was higher than that, but I will trust that you are right. The
fund started in June of 2000, so the six-month number in 2000
was around that kind of number versus calendar year 2001. The
S&P in 2001 was down approximately 12%. Versus the S&P
it was really good, but clearly we did not have the best names
in our Small Cap Fund or enough of them, since the Small Cap
Fund did so much better.
Large value did not
perform anywhere near as well in 2001 as did small caps.
Ric Dillon: Probably what happened was the
large value names that we did have held back the performance at
bit. While we might have had a dominant position in the small
cap, it was not enough. We should have had everything in small
caps, one could say in hindsight, because the Long/Short Fund
clearly did not do nearly as well in 2001 as the Small Cap Fund
did. There was hardly any difference though in 2002. Then in
2003, of course, small cap again was great. In 2003, it was
long/short, so it lagged considerably. Now this year small caps
lagged, so the Long/Short Fund was actually better than the
Small Cap Fund this year.
What is the fundís
market capitalization rate? Is there a cap as to the size of the
company that you go after, or is it just a general range?
Ric Dillon: It is a general range. The only
thing that we will not do is buy positions with market caps
under $500 million, just because we reserve that exclusively for
our Small Cap strategy. That is the only caveat we put on it. We
have had the bias, admittedly not enough in 2001, towards small
cap the first three years. That bias has pretty much gone away
How about on the
micro-cap side, do you run into any liquidity issues?
Ric Dillon: No, as long as we stay out of the
sub-$500 million, I do not think we have had any issues. There
has been only one company that we filed a 13 D, on and that was
a sub-$500 million company in the Small Cap. That is why we do
it, so we do not run into those kind of liquidity issues.
Do you have a target for
a number of positions in either of the funds?
Ric Dillon: Yes. In the small cap the
prospectus talks about a range of 30 to 50, and it finished the
year right around 50. In the next prospectus, the small cap
might say 40 to 60. We do not want to have too many names. In a
small cap portfolio, even 60 might be considered a few numbers
out of the Russell 2000. We may have to relax that a little bit.
On the Select strategy, which again is the long part of the
long/short strategy, our range for the number of stocks in the
portfolio is 25 to 35. We finished 2005 around 30. On the short
side we also finished around 30. Definitely Select, as the name
suggests, or as the former name All Cap Concentrated indicates,
shows that it is intended to be a more concentrated portfolio
than our long-only strategies like small cap or even large cap.
Who were some of your
contributing performers or sectors on the short side?
Ric Dillon: We did make some money last year
on the short side, maybe 3% or 4%. I know we had good results
from being short the auto companies. In some of the other
consumer discretionary areas and even some tech areas we did
well on the short side.
Are you looking to keep a
relatively similar position on the short side?
Ric Dillon: Yes. We have not made any major
changes, just little things around the edges. This is always
somewhat surprising, but even in our Long/Short Fund we have low
That is very surprising.
Ric Dillon: Regarding the Partnership,
which I mentioned has been long/short for five years now, we
have been short several of the short names the entire five
That is a sign of
Ric Dillon: Yes. Cisco Systems is a great
example of that, Wal-Mart another good example. Both are much
closer to being fairly valued where we would cover them, so
maybe in 2006 they will both be gone as short positions. But for
five years we have been short names like that.
Do you find it a little
more difficult to play the long/short strategy when there is a
lack of volatility in the market?
Ric Dillon: No, probably not. The reason is
that the volatility, as you know, is measured on an annual
basis, and since we are looking at things in longer time
periods, the short-term volatility really does not play as much
of a role for us as it would for someone who has much higher
Morningstar does not
provide an expense ratio on the Long/Short Fund, institutional
share class. Could you give us an estimate?
Ric Dillon: There is a 90-basis-point
management fee, and there is a 20-basis-point administrative
fee. In addition to those two, there is something that is always
going to be a little different. That is, the other expenses
which are almost exclusively dividends of stocks that are
shorted, have been running around 20 basis points. I do not know
why they do not give that, but I think a good number to use
would be 130 basis points. It might be a little less than that,
but the 90 and the 20 are a given, so that is 110 basis points.
And there is always going to be some expenses associated with
dividends of stocks being shorted. It has never been a big
number, but 15 to 20 basis points is probably a good guess.
What is the reason for
the focus on going large cap in the Long/Short Fund? Why have
not you started a small cap long/short fund?
Ric Dillon: What we are really trying to do is
just find the best ideas, no matter where they are in the market
cap spectrum. The reason it has become more large cap on the
long side is driven by the opportunities in the energy area.
There are only two holdings that are small cap. Everything else
in the energy area happens to be large cap. I think it is just
nature that energy companies tend to be larger companies.
Burlington, Devon, ConocoPhillips, Anadarko, and Apache are all
large cap names.
Do you anticipate adding
any new investment personnel in the near future?
Ric Dillon: As far as adding to the team of
five that I mentioned, Chuck, Tom, Chris Welch, Chris Bingaman,
and myself, I would say the answer is no. None have been
contemplated, nor discussed, so it will stay at that for at
least the next six months. On the analytical and trading support
side, in addition to Jason and Bhavik, I would guess that there
would be at least one or two added.
How much of the
principalsí personal monies are in these strategies?
Ric Dillon: On the equity side, if you exclude
residential real estate and company stock, for me it is 100%.
For the others it is either 100% or pretty close to it. I think
that Chuck has some municipal bonds, and that would be the one
exception. We do not have separate accounts personally, so I
cannot buy Devon or any of these energy names because I have to
put my money in the funds. With the mutual fund disclosure, you
can see all this disclosed. We have substantial representation
in our funds. What you will not see is the partnership. Many
others have a lot in that as well. But we cannot buy individual
stocks, instead we have to put it in either the mutual funds or
Is the partnership
relatively the same securities as the Long/Short Fund?
Ric Dillon: Absolutely, itís just the
leverage that is the difference. One of the things we do not
want to ever have is a conflict of interest. In our Select
strategies, those being our favorite ideas from our large cap
and our small cap and the Select is that long portion of the
long/short, we cannot buy anything in the Select strategy, i.e.
the long side of long/short, unless we also have it in the large
and/or the small cap. So it has to be a subset. And if we really
like Cimarex, which is a small cap energy name, we have to have
it in the Small Cap Fund or be buying it simultaneously in the
Small Cap Fund to put into our Select strategy or into our
Long/Short strategy, for the obvious reason that if we did not
have such a rule, we could be accused of making investments only
in certain portfolios where we have our own money. Worse, in the
Partnership where we earn an incentive fee, we could be accused
of putting our best ideas there because that is where we have an
incentive fee, so we cannot do that. You can see every holding
on the long side of our Long/Short Fund and find them either in
the Large Cap and/or the Small Cap Fund if you go to our website
and get a copy of our semi-annual report for our mutual funds.
You can go through and check every single holding and you will
find that. You will also see that not a single holding that we
are short is long anywhere else. We have very carefully put
these processes and procedures in place to make sure we do not
have any kind of conflict of interest. We can make mistakes, but
they are not going to be out of a conflict of interest.
Can you describe for us
how the stocks get on either your long or short list? What is
your process? Occasionally we run into long/short managers that
actually have two different processes.
Ric Dillon: We have just the one process. What
we are doing is looking at all the companies that would be in
the universe of roughly 3,000. We start with a first
approximation on all those companies, which comes from different
data sources that are input into algorithms. This process is
fully discussed and disclosed on our website. This is something
that is both our proprietary and intellectual property and
software, but you can read about it. Then we go into each
particular stock that we are looking at that might be of further
interest. Letís take Yahoo, for instance, which we are short,
but it says we have gone through all this and we have Yahooís
top line growing at 20%, and the margin actually expanding. The
stock is only worth $23 a share but it is selling at $40. Then
we will short it. That is how we do it. On the long side, with
energy stocks such as ConocoPhillips, we say we think that the
various crude prices and natural gas prices are going to act a
certain way, and we think that the stocks should still sell at a
discount, but not as much of a discount that it currently sells
for. We believe that the present value of the company is $80 and
it is selling at $59, so we go long. That is how we do it.
When you hold a stock and
it gets so large that it moves into a higher capitalization
range, is that an automatic sell?
Ric Dillon: No. The only thing we will not do
is initiate a purchase, but other than that we essentially
ignore it and continue to hold it as long as we think it adds to
the portfolio value.
If you had something in
your Small Cap Fund that you deemed it was time to move out of
because of the appreciation factor, would you automatically sell
it out of your Long/Short Fund?
Ric Dillon: Again, we would not sell it
because of the appreciation factor unless it became fairly
valued. But absolutely, we cannot own anything in our Long/Short
Fund that we do not own in our Large Cap or our Small Cap Funds.
Ric, thank you very much.
Ric Dillon: Thank you very much. We appreciate
Legend Financial Advisors, Inc.ģ
5700 Corporate Drive, Suite 350
Pittsburgh, PA 15237-5829
Phone: (412) 635-9210
Fax: (412) 635-9213
Toll Free: (888) 236-5960
Web Site: www.legend-financial.com