An active value and quality-based approach can be an advantage in a part of the stock market dominated by index funds
Red Rock Resorts, which manages Red Rock Casino in Las Vegas, is the fourth-largest holding of the Diamond Hill Small Cap Fund.
So far, 2026 is turning out to be a very good year for small-cap stocks, following a long period during which this group underperformed large caps.
Through Tuesday, the Russell 2000 Index RUT - by general consensus the U.S. benchmark for small-cap stocks - had returned 20.2% for 2026, outperforming the S&P 500 SPX, which had returned 10.9%. For five years through 2025, the Russell 2000 had returned 34%, way behind the S&P 500's return of 96%, according to data provided by FactSet. All performance figures in this article include reinvested dividends.
The Diamond Hill Small Cap Fund DHSCX has outperformed the Russell for both periods, returning 25% so far in 2026, following a five-year return of 74% through 2025.
"I don't wait for the Russell 2000. I want to provide good returns at any time," Aaron Monroe, the fund's portfolio manager, said during an interview with MarketWatch. He emphasized the importance of identifying stocks of companies that are priced below the Diamond Hill team's estimates of intrinsic value.
"For us, that means treating every stock as an ownership stake in the business," he said.
The Diamond Hill Small Cap Fund had $231 million in assets under management as of June 30. Diamond Hill is based in Columbus, Ohio, and has about $23 billion in assets under management through several strategies across various funds and individual accounts. The firm was acquired by First Eagle Investments in April and continues to operate under its own management as a subsidiary of First Eagle.
An advantage as passive approaches dominate
Monroe said that he had seen "numbers ranging from 50% to 70%" as estimates for the percentage of money invested in the small-cap space through passively managed index funds, up from roughly 20% in 2002. He added that "assets are being consolidated," with the top five managers controlling more than half of the small-cap space.
"This creates a big pool of capital that is fairly neglected," he said, which has led to a declining amount of research coverage of small-caps within the brokerage industry and "less price discovery."
These trends underscore the importance of money managers having their own research capability.
'Many of these companies are perpetually misunderstood.'Aaron Monroe, portfolio manager of the Diamond Hill Small Cap Fund
"You have an opportunity set that is rich," Monroe said. He described Diamond Hill's "workmanlike mentality to investing," which includes forecasting companies' fundamental performance at least five years out, supported by "a qualitative assessment of companies we want to own."
Monroe said the Russell 2000 could be divided into three groups of companies. He described one group as "highly innovative with binary outcomes." These can include single-product biotechnology companies and other tech-oriented businesses. He finds this group to be "challenging to own in a market where liquidity is a luxury."
The next group within the index was described by Monroe as "distressed companies looking for a strong economy to become successful," which he believes is equal in risk to the first group.
The last third of the Russell 2000 is where Monroe focuses on building a portfolio of 50 to 60 stocks, which tends to be fairly concentrated, with the top 30 holdings making up about 70% of the portfolio. These are companies "with real moats - businesses with capacity to suffer and the ability to endure, [which provide] long-term opportunities to deploy capital," he said. By forecasting five years of revenue and profit margins, Monroe, supported by the research team at Diamond Hill, arrives at what he described as "optimal free cash flow for the company" in its peak year. This is discounted back to determine whether the stock is currently trading at an attractive price, he said.
Monroe said he was looking for businesses positioned to defend their competitive positions for the next five to 10 years. He also prefers companies with "high inside ownership." And if the companies have debt, he wants to make sure it is "backed by assets or steady cash flow."
"Many of these companies are perpetually misunderstood," Monroe said. "This recipe gives me the ability to deploy capital to these companies when they trade below intrinsic value," along with confidence to invest more during periods of industry drawdowns, he said.
Examples of stocks held by the fund
When asked if he visited companies when deciding whether or not to invest in them, Monroe said he did, giving Red Rock Resorts (RRR) as an example. Red Rock manages casino resorts owned by Station Casinos LLC, which Red Rock controls with 100% of voting shares while owning a 59% indirect stake.
Red Rock Resorts was the fourth-largest holding of the Diamond Hill Small Cap Fund as of June 20, making up 5% of the portfolio. The fund has held the stock for more than 10 years.
Monroe said that before the COVID-19 pandemic, there was a trend among casino operators to split into operating companies and property owners. "Red Rock refused to do so," he said. When the casino industry shut down during the pandemic, owning so many properties, including developed and undeveloped land in Las Vegas, enabled Red Rock to weather a period of zero revenue and even to invest in the business for the long term, because of its ability to mortgage properties.
"They took the opportunity during the shutdown to rework the enterprise, to come out as a better, more profitable business," Monroe said. He added that the company now runs property margins (operating income as a percentage of revenue) ranging from 40% to 46%, improving from the "mid-30s" before the pandemic.
Monroe also said that owning a significant amount of undeveloped property in Las Vegas helps Red Rock avoid "having a competitor grow next door to them."
Getting back to the "ownership mindset," Monroe said that because Frank J. Fertitta and Lorenzo J. Fertitta, brothers who serve as the chair/CEO and vice chair, respectively, of Red Rock, have large ownership stakes and "super voting rights," they will have the "same experience I will have as a passive shareholder."
Another example Monroe mentioned was U.S. Lime & Minerals $(USLM)$, which is based in Dallas and supplies road-construction contractors, as well as companies involved in environmental work and industrial production, through plants and distribution facilities in Texas, Arkansas, Colorado, Louisiana, Missouri and Oklahoma.
Monroe said the Diamond Hill team had purchased U.S. Lime shares "four or five years ago," at a time when the stock was trading at a significant discount to the much larger Martin Marietta Materials (MLM).
U.S. Lime is not widely covered - only one analyst polled by FactSet covers the stock, so a typical comparison of forward price/earnings ratios doesn't apply. On a trailing 12-month basis, U.S. Lime trades for 32.3 times free cash flow, while Martin Marietta Materials trades for 33.5 times trailing free cash flow, according to FactSet.
But Monroe pointed to a different valuation metric based on earnings before interest, taxes, depreciation and amortization. According to FactSet, U.S. Lime's ratio of enterprise value to trailing Ebitda is 14.5, while this ratio for Martin Marietta Materials is 19.2.
"U.S. Lime has a net-cash balance sheet. Texas is continuing to grow. Lime slurry is used to stabilize the ground for construction in Texas," Monroe said. So he likes the long-term business prospects for a company that "focuses on the I-35 corridor, with a mandatory piece in the growth mechanics."
He also feels comfortable about the ownership of U.S. Lime, with one long-term shareholder, George M. Doumet, controlling a stake of more than 60% through Inberdon Enterprises, as verified by FactSet.
Another example of a stock held by the fund is UFP Technologies $(UFPT)$, which Monroe said "was categorized as a materials business when we bought it, but really it was a healthcare business."
"They have exclusive to semi-exclusive access to 14 materials" used to supply medical-device manufacturers, he said, emphasizing UFP's competitive advantage because of difficult barriers to entry for the industry.
One customer of UFP is Intuitive Surgical $(ISRG)$, the developer and manufacturer of the da Vinci robotic surgical platform. UFP makes single-use surgical drapes for use on each of the surgical arms on the da Vinci systems.
"That is what is fascinating in small-market businesses," Monroe said. For companies with competitive advantages, "more often than not, the economics will continue to deliver, or they will be bought."
Top holdings of the Diamond Hill Small Cap Fund
Here are the fund's top 10 holdings (out of 56) as of June 30:
Company % of Diamond Hill Small Cap Fund portfolio as of June 30 Astrana Health 6.2% Triumph Financial 5.2% Ducommun 5.1% Red Rock Resorts 5.0% Ryman Hospitality Properties 4.8% UFP Technologies 4.1% Bank OZK 4.0% Mesa Laboratories 3.5% Utz Brands 3.5% Magnolia Oil & Gas 3.4% Source: LSEG
Performance against competing funds
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July 15, 2026 10:23 ET (14:23 GMT)
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