John Rogers' Ariel Appreciation Fund Second Quarter 2013 Commentary
Wow, that happened fast. Or so we think many investors would say. For a typical U.S. investor holding a portfolio diversified across domestic stocks, foreign stocks and bonds, the year started quite well. Through the first four months, there were down months here and there in an asset class or two, but most holdings showed gains— handsome ones in stocks. Cracks showed in May in foreign stocks and bonds, and then most everything fell in June. U.S. bonds lost more than -1% (for the second straight month), emerging market stocks lost more than -6% and domestic large-caps lost more than -1%. Those losses seem minor by comparison to gold, which as reported in The Wall Street Journal, "fell -23% in the second quarter, the biggest quarterly decline since trading of U.S. gold futures began in 1974." Conventional wisdom holds that it was Ben Bernanke's mid-June comments about quantitative easing that spurred the rout. To our minds, he simply signaled that quantitative easing would slow down at some point, which we would have thought an obvious truth. Many reacted, however, as if it was new and harsh news. We were pleased that the effects were less dramatic on our investment universes than they were on the recently popular areas such as bonds, emerging markets stocks and gold. So it is with pleasure that we note our positive returns during a difficult quarter. In the second quarter of 2013, Ariel Appreciation Fund returned +4.35%, outpacing the Russell Midcap Value Index and the Russell Midcap Index, which rose +1.65% and +2.21%, respectively.
Several of our stocks posted strong returns this quarter. Advertising holding company Interpublic Group of Cos., Inc. (NYSE:IPG) gained +12.27% after reporting a solid earnings quarter. The company's reported loss of -$0.13 per share was in line with analyst estimates, and contained significant good news below the headline. Specifically, organic revenue rose +2.3% globally and much better in Latin America and other key growth geographies. Crucially, the company retired its entire $200 million in 4.75% convertible senior notes, thereby bolstering the firm's capital structure. In addition, IPG repurchased 6.2 million shares of stock over the course of the quarter and increased the dividend by 25 percent. In other words, we were pleased with the way management made the key decisions under its control. Consultant Towers Watson (NASDAQ:TW) surged +18.21% as investors became increasingly aware of the potential for gains driven by the Affordable Care Act's implementation. Specifically, Towers Watson is largely known as a defined benefit plan pension consultant; it also, however, consults on related issues and has a health care consultancy. Moreover, in 2012 it purchased Extend Health, which was at the time the largest private Medicare exchange in the US. As businesses deal with the uncertainties stemming from this significant change, they naturally are seeking expertise—and Towers Watson is a go-to specialist in the field. Although we certainly do believe there is value in this part of the company's business, we have recognized it for some time, while the market seems to be treating it as new information.
Some of our holdings struggled in the second quarter. Mortgage insurer First American Financial Corp. (NYSE:FAF) slid -13.35% despite a good overall quarter. We believe the market was essentially confused. The company's official earnings per share were $0.33 versus the $0.42 consensus. The key reason for the miss, however, was a large reserve charge dating to the 2006-2007 period. Without the charge, earnings would have been roughly $0.44 per share. Revenues exceeded expectations by increasing +19%, and purchase orders were up +13%. Admittedly, those were trade-offs for refinancings, which were down -7%. Management was upbeat and optimistic about business, a perspective we think was fully justified. The stock now trades below 1x book, which we think is very cheap given its profitability, powerful market position and business trajectory. Natural gas producer Contango Oil & Gas Co. (MCF) slipped -15.81%, largely due to an acquisition. The company was also negatively affected by both the write down of a key reserve and a one-off maintenance on an important well. Clearly, however, the most important event was the acquisition of Crimson Exploration (NASDAQ:CXPO). The market responded as if it were a surprise, but we did not think it one. That is, Contango had always operated with no debt, and eventually it would follow one of two paths: sell itself to a larger producer or use its balance sheet to acquire a distressed, leveraged competitor. In doing the latter, Contango emerges with more assets, more cash flows and yet has low leverage. We continue to admire the company and believe it to be quite cheap.
During the quarter, we exited two positions in Ariel Appreciation Fund. We eliminated Accenture plc (NYSE:ACN) when it reached a full valuation based on similarly full expectations. We also sold Life Technologies Corp. (NASDAQ:LIFE) on the news that Thermo Fisher Scientific Inc. (NYSE:TMO) had signed a definitive agreement to acquire it for $76 per share.
For our part, we have not looked to ultra-low interest rates, quantitative easing or any other monetary policies to guide our investing. That is, we have been confident all along they would have their intended effects—to help stimulate the U.S. economy—but we never saw them as driving our investment process. So we find it odd when we hear some were attempting to act with highly precise timing, to use "easy money" as long as it lasted and then shift to different assets just before the policy changed. All along, we have looked toward individual companies we thought were trading at cheap prices relative to their likely futures in the U.S. economy. We not only have followed that policy for the last several years, but we have always done so and expect to do so moving forward.
This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
As of 6/30/13, Interpublic Group of Cos., Inc. comprised 4.4% of Ariel Appreciation Fund; Towers Watson 3.3%; First American Financial Corp. 3.4%; Contango Oil & Gas Co. 1.2%, Crimson Exploration 0.0%; Accenture plc 0.0%; Life Technologies Corp. 0.0%; and Thermo Fisher Scientific Inc. 0.0%. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Appreciation Fund.
The Russell Midcap® Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. It includes those Russell Midcap Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell Midcap® Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap Index represents approximately 27% of the total market capitalization of the Russell 1000 companies. Russell® is a trademark of Russell Investment Group, which is the source and owner of the Russell Indexes' trademarks, service marks and copyrights.
Bonds are fixed income securities in that at the time of the purchase of a bond, the amount of income and the timing of the payments are known. Risks of bonds include credit risk and interest rate risk, both of which may affect a bond's investment value by resulting in lower bond prices or an eventual decrease in income. Treasury bonds are issued by the government of the United States. Payment of principal and interest is guaranteed by the full faith and credit of the U.S. government, and interest earned is exempt from state and local taxes. Investments in foreign securities may underperform and may be more volatile than comparable U.S. stocks because of the risks involving foreign economies and markets, foreign political systems, foreign regulatory standards, foreign currencies and taxes. Investments in emerging and developing markets present additional risks, such as difficulties in selling on a timely basis and at an acceptable price. The value of investments in gold can be extremely volatile and change quickly and can be affected by political and economic factors, supply and demand, the value of currencies, and speculation.
Investors should consider carefully the investment objectives, risks, and charges and expenses before investing. For a current prospectus or summary prospectus which contains this and other information about the funds offered by Ariel Investment Trust, call us at 800- 292-7435 or visit our web site, arielinvestments.com. Please read the prospectus or summary prospectus carefully before investing. Distributed by Ariel Distributors, LLC, a wholly-owned subsidiary of Ariel Investments, LLC.