Investing in small and mid-cap stocks is more risky and more volatile than investing in large cap stocks. The intrinsic value of the stocks in which the portfolio invests may never be recognized by the broader market. Investing in equity stocks is risky and subject to the volatility of the markets. Ariel Fund often invests a significant portion of its assets in companies within the financial services and consumer discretionary sectors and its performance may suffer if these sectors underperform the overall stock market.
Performance data quoted represents past performance. Past performance does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains and represents returns of the Investor Class shares. 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. Current performance may be lower or higher than the performance data quoted. For the period ended March 31, 2014, the average annual total returns of Ariel Fund (Investor Class) for the one-, five- and ten-year periods were +23.74%, +30.25% and +7.37%, respectively. Ariel Fund's Investor Class shares had an annual expense ratio of 1.03% for the year ended September 30, 2013. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our web site, arielinvestments.com.
Quarter Ended March 31, 2014
Global equity markets both at home and abroad decelerated significantly in th e first quarter of 2014. After the supercharged 2013 campaign, such a slowdown hardly comes as a surprise. Afte r all, equities tend to gain roughly +10% annually over the long term, depending on market cap, region, and valuation. In 2013, however, the S&P 500 gained +32.39 %, and the MSCI EAFE jumped +23.29%. After such a run, therefore, it was no shock to see hot markets cool down. To that point, in the first quarter, the S&P 500 returned +1.81%, while the MSCI EAFE earned just +0.77%. Indeed, underneath those top- line returns, were areas of demonstrable weakness. For instance, the Dow Jones Indust rial Average lost –0.15%, and our domestic portfolios, which mostly performed nicely last year, fell short in the first quarter of 2014. We had soft returns this quarter as Ariel Fund dropped -0.99%, lagging the Russell 2500 Value Index's +3.52% advance as well as the +1.78% rise of the Russell 2000 Value Index.
Several of our holdings posted strong returns this quarter. Real estate specialist JLL Inc. (JLL), previously known as Jones Lang LaSalle Inc., surged +15.73% due to a strong earnings report. Specifically, in late January the company reported better-than-expecte d (adjusted) earnings per share (EPS) of $3.33; the Street expected $3.09. Revenues topped forecasts, $1.5 billion rather than $1.3 billion. In addition, the company's operating results were boosted by solid investment sales, facility management services and momentum in leasing revenues. Moreover, management signaled continued improvemen ts across its businesses. The market is still applying a cautiously cyclical set of expectations to this firm, but we believe its gradual growth is more secular in nature. Cruise line Royal Caribbean Cruises Ltd. (RCL) steamed to a +15.61% gain after a very strong earnings report. Specifically, it earned an adjusted $0.23 per share, topping the $0.18 consensus expect ation handily. It also set an earnings-per-share expectation of $2.40 for the year. The company had other good, forward-looking fundamentals. Pricing is above last year's levels, and booking has gone up in the three out of four of the next year's quarters (and is flat in the fourth). In the wake of Carnival's recent troubles, too many people assumed the cruising industry was in decline. We believe the fundamentals of the industry are intact and thought Royal's stock had been unfairly punished. We think the recent rise is the beginning of a wide spread adoption of that view.
A few of our holdings struggled at quarter end. Credit specialist Dun & Bradstreet Corp. (DNB) slid –18.69% after its CEO issued weak guidance. Specifically, in early February the company reported mixed results. Revenues were higher than forecast and earnings were lower. What ca ught the Street somewhat off- guard was new CEO Bob Carrigan's forward guidance for 2014 EPS—a drop of roughly –1% to –5%. Given that his plan is to drive revenue growth and reinvest in the business, rational long-term investors should have been pleased in our opinion. Although there is obviously a difference between a sound strategy and successful implementation, we were satisfied with the plan. Gaming manufacturer International Game Technology (IGT) returned -22.00% after a subpar earnings report. Its revenue and earnings per share both slid below consensus estimates. Specifically, revenues were 2% lower than Wall Street expected, while the (adjusted) EPS of $0.25 did not meet the $0.30 forecast. The miss came from weak regional gaming trends as well as higher than expected operating expenses. We think operating issues can be corrected and believe management is focused on the issue. In the meantime, we see light business as temporary and industry-wide— beyond IGT's control. We would be more concerned were the short-term results stemming from lost market share, for instance. Although there have been headwinds for this company, we remain optimistic over the long term.
During the quarter we added two new positions to Ariel Fund. During the quarter we purchased Bally Technologies Inc. (BYI) in our small cap value portfolio. With an estimated $1.2 billion in fisc al year 2014 revenues, Bally Technologies has become one of the larger gaming equipment and systems companies in the world. At this time, we believe the investment community is too focused on what we consider to be short-term issues, such as disappointing attendance and play at regional casino operators. We are confident that Bally is poised to benefit from gaming growth, both domestically and internationally. We also a dded a previous Ariel holding, Laboratory Corp. of Americ a Holdings (LH). LabCorp maintains a leading market position in an industry that continues to show promising growth potential due to technological advances, agin g demographics, health-care cost containment, and prev entative medicine. LabCorp maintains a solid balance sheet, generates a significant amount of free cash flow, and has been returning value to shareholders through share repurchases. The company operates with an experienced management team that is conservative yet willin g to take slight risks in order to grow the business long-term. We did not eliminate any positions this quarter.
Although, clearly, the stock mark et changed course during the quarter, our own long-term view s have not. First and foremost, although we do not generally engage in short-term stock market prognostication, we think the past three months have been a pullback rather than the beginning of a correction or bear market. Our reasoning follows. Although aggregate valuation measurements such as the market's price-to-earnings (P/E) ratio started the year toward the high end of the typical range, they are now closer to normal. Moreover, the economy continues to slowly but surely improve based on our assessment of the economic da ta we see; the management teams we interview on a daily basis further bolster this view with their confidence and genera l optimism. So we continue to hold the same view we did at the beginning of the year: Equities are likely to rise in 2014, just not as much as in 2013.
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 3/31/14, Jones Lang LaSalle Inc. comprised 3.8% of Ariel Fund; Royal Caribbean Cruises Ltd. 3.7%; Dun & Bradstreet Corp. 2.6%; International Game Technology 2.9%; Bally Technologies Inc. 2.3% and Laboratory Corp. of America Holdings 1.4%. Portfolio holdings are subject to change. The performance of any single portfo lio holding is no indication of the performance of other portfolio holdings of Ariel Fund.
The Russell 2500™ Value Index measures the performance of the small to mid-cap value segment of the U.S. equity universe. It includes those Russell 2500 co mpanies with lower price-to- book ratios and lower forecast ed growth values. The Russell 2000® Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lowe r price-to-book ratios and lower forecasted growth values. Russell® is a trademark of Russell Investment Group, which is the source and owner of the Russell Indexes' trademarks, service marks and copyrights. The S&P 500® Index is the most widely accepted barometer of the market. It includes 500 blue chip, large cap stocks, which together represent about 75% of the total U.S. equities market. MSCI EAFE ® Index is an unmanaged, market weighted index of companies in developed markets, excluding the U.S. and Canada. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data cont ained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The DJIA was invented by Charles Dow back in 1896.
Investors should consider carefully the investment objectives, risks, and char ges 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.