Investing in small- and mid-cap stocks is riskier 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. 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 December 31, 2014, the average annual total returns of Ariel Fund (Investor Class) for the 1-, 5- and 10-year periods were +10.95%, +16.62% and +7.16%, respectively. Ariel Fund’s Investor Class shares had an annual expense ratio of 1.03% for the year ended September 30, 2014. 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 website, arielinvestments.com.
Quarter Ended December 31, 2014
In the fourth quarter of 2014, the U.S. stock market continued one recent pattern and broke another. The large-cap S&P 500 Index gained +4.93% and the small-cap Russell 2000 Index gained +9.73%. On an absolute level, it was a very strong quarter, which continues the pattern for fourth quarters since 2009: With only one exception in 2012, both indices have posted gains in the final three months of the year. In 2010, 2011 and 2013, at least one of the two had double-digit percentage returns, and the Russell 2000 was obviously tantalizingly close this year. On the other hand, it reversed the market-cap trend for 2014. In the first nine months of the year, the larger the market-cap range, the better the performance: Large beat mid, which beat smid, which topped small, which outdid micro. That order was essentially reversed in the fourth quarter.
The story was different overseas for the quarter and year. Specifically, international stocks retreated modestly over the recent 3- and 12-month periods. The MSCI EAFE Index gave up -3.53% in the quarter and -4.48% in 2014. Fears of a European downturn, recession in Japan and a global shock starting in China were the main culprits. This quarter, Ariel Fund jumped +8.52% and finished ahead of the Russell 2500 Value Index’s +6.09% gain but not the +9.40% rise of the Russell 2000 Value Index.
Some of our holdings rose significantly for the quarter. Mortgage insurer First American Financial Corp. (FAF, Financial) surged +25.91% as its business gained momentum. Its earnings per share for the quarter were in line with expectations (excluding investment gains and taxes), while claims were lower than expected. More importantly, residential purchases strengthened recently, and the commercial outlook is quite good. The company has had good earnings the past few years while swimming upstream, so it should do even better if a moderately favorable environment emerges. Credit specialist Fair Isaac Corp. (FICO, Financial) rose +31.25% after reporting a strong quarter. The company’s revenues and earnings beat expectations, with earnings per share hitting $1.10 against the $0.89 consensus. The firm’s applications business in particular did well, growing +23% to drive overall revenues up +16%. In our view, this company continues to compound capital nicely, increasing its intrinsic value gradually.
Other holdings slid in the short term. Tool and coating maker Kennametal Inc. (KMT, Financial) dropped -12.97% due to short-term weakness in orders. At the end of October and November, the company reported declines of -1% and -3% in orders,
respectively. While industrial orders have been up, infrastructure orders have been light. Kennametal is one of only three significant players in a critical niche field, and while there may be fundamental volatility short-term, the long-term demand trend for its products looks very promising. Also, industrial sand provider U.S. Silica Holdings, Inc. (SLCA, Financial) fell -58.71% alongside falling oil prices. As you know, oil prices dropped precipitously this quarter, from the high $80s to the low $50s in just three months. Because U.S. Silica’s business is admittedly tied closely to oil production, shares fell in near lockstep. We think the value of energy and energy-related companies are not wholly determined by volatile commodity prices, and we especially seek out those with differentiated businesses. We like U.S. Silica’s advantageous geographical positioning and its best-in-class logistics. Natural resource production may flex with commodity price moves, but we think producers will ultimately choose Silica’s products over competitors’, giving it a significant economic moat.1
During the quarter, we did not add or exit any positions in Ariel Fund.
At Ariel we change our outlook due to fundamentals, not by turning calendar pages. So our outlooks from one January to the next have not differed a great deal lately. In our view, the fundamentals have remained fairly stable, and the same is true at the beginning of 2015. Regarding the U.S. economy and market, we remain confident and optimistic about U.S. growth and are only mildly cautious about valuation; this view is similar to the one we held as 2014 began. We are coming off a year of standard stock market performance, economic growth remains fairly slow and gradual, and a fair mix of optimism and pessimism pervades the investing crowd. Abroad, we think a bit more economic risk remains, but it is somewhat balanced by valuation. The big fears regarding Europe and China are 1An economic moat is a perceived competitive advantage that acts as a barrier to entry for other companies in the same industry. This perceived advantage cannot protect investors from the volatility associated with stocks, incorrect assumptions or estimations, declining fundamentals, or external forces.
indeed concerning to us: A recession for the European Union does seem likely, and the world’s most populous nation clearly has economic issues to settle. That said, foreign stocks retreated a bit this year, and valuations look lower around the globe than they are in the United States.
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 12/31/14, First American Financial Corp. constituted 3.7% of Ariel Fund; Fair Isaac Corp. 2.4%; Kennametal Inc. 3.1%; and U.S. Silica Holdings, Inc. 2.1%. 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 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 companies with lower price/book ratios and lower forecasted 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 lower price/book ratios and lower forecasted growth values. The Russell 2000® Index is a subset of the Russell 3000® Index, representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities on the basis of a combination of their market cap and current index membership. 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. The MSCI EAFE® Index is an unmanaged, market-weighted index of companies in developed markets, excluding the U.S. and Canada. The MSCI EAFE Index (gross) returns reflect the reinvestment of income and other earnings, including the maximum possible dividends. MSCI makes no express or implied warranties or
representations and shall have no liability whatsoever with respect to any MSCI data contained 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. (Source: MSCI.)
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 website, 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.
