Investing in mid-cap stocks is riskier and more volatile than investing in large-cap stocks. The intrinsic value of the stocks in which the Fund invests may never be recognized by the broader market. Ariel Appreciation 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 September 30, 2015, the average annual total returns of Ariel Appreciation Fund (Investor Class) for the 1-, 5- and 10-year periods were - 3.89%, +11.92% and +7.22%, respectively. The Fund’s Investor Class shares had an annual expense ratio of 1.12% for the year ended September 30, 2014. Performance data current to the most recent month-end for Ariel Appreciation Fund may be obtained by visiting our website, arielinvestments.com.
Quarter Ended September 30, 2015
Equities had a difficult quarter across regions, market cap ranges and styles. The U.S. large-cap S&P 500 Index fell -6.44%, the U.S. small-cap Russell 2000 Index dropped -11.92%, while the international, developed large-cap MSCI EAFE Index slid -10.23%. There was significant narrative fuel for the fire: worries that a slowing Chinese economy would spur a global economic slowdown; hand-wringing over the timing of the U.S. Federal Reserve’s likely interest rate increases; and fretting over falling commodity prices. As a result, many types of stocks have “corrected,” a term that tends to inspire fear and worry despite the potential upside corrections create.
This quarter, Ariel Appreciation Fund fell -13.57%, lagging the Russell Midcap Value Index’s -8.04% slide, as well as the -8.01% return of the Russell Midcap Index.
Some of our holdings held up relatively well in the very difficult quarter. Mortgage insurer First American Financial Corp. (FAF, Financial) gained +5.68% due to a strong earnings report. Wall Street anticipated solid revenue growth but once again underappreciated the company’s powerful operating leverage. As a result, the company’s $0.83 per share in operating earnings smashed the $0.67 consensus estimate. We continue to think the company is in very good shape in a soft but improving housing market and can do even better if housing fully recovers. Jam, peanut butter and coffee king J.M. Smucker Co. (SJM, Financial) rose +5.88% after topping quarterly expectations. Its adjusted EPS of $1.32 was significantly better than analysts’ comparable $1.23 estimate. The coffee segment grew nicely due to the introduction of Dunkin’ Donuts K-Cups. Additionally, Smucker’s acquisition of Big Heart Pet Brands is already going well. The gradual transformation of the business over the past few years has been impressive, and we expect more fundamental improvement.
Other holdings underperformed in the falling market. Helicopter services specialist Bristow Group Inc. (BRS, Financial) descended -50.45% amid a turbulent environment. As you know, oil prices have plummeted, causing Bristow’s customers to swiftly downshift—especially in the North Sea. Earnings were therefore only $0.56 per share, well below the $0.91 estimate; management also lowered guidance for the year. While these are not long-term issues in our view, the stock is likely to be volatile over the short term. We continue to believe in the company’s business model, management team and long-term position. Specialty cutting tool maker Kennametal Inc. (KMT, Financial) returned -26.58% despite a reasonable earnings report. The company’s adjusted earnings were $ 0.46 per share, and unadjusted earnings were $0.26 per share; the expectation had been $0.24. The market focused on the bottom line, which was down nearly -42% from the year before. End-market demand is temporarily weak, and energy-related customers—which are a small part of the overall base—have shown especially low demand. Short-term we think the company will work its way through the challenges, and long-term we think the market is overlooking the company’s strong positioning in an important niche.
During the quarter, we purchased Progressive Corp. (PGR, Financial) in Ariel Appreciation Fund. Progressive is the fourth-largest auto insurer by market share in the U.S. Investors are skeptical of the company’s growth potential and margin sustainability (given intense competition, a recent move into homeowners and rising frequency losses). We, however, see this as an opportunity for long-term investors to own a rare example of a differentiated insurer, well-positioned to benefit from continued share gains, direct channel efficiencies and eventually, rising interest rates. We did not exit any positions during the quarter.
We do not share the pessimistic view that has sidelined many investors. Again, a stock market correction typically means equities are cheaper. Given our previously-expressed concern that stock prices were becoming a bit stretched, we do not mind seeing the market’s aggregate valuation level drop. Moreover, given the volatility and resulting price dislocations, our view is that more bargains are at hand. We encourage long-term investors to remain rational, avoid panic, and stick to a sensible asset allocation strategy.
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 2000® Index measures the performance of the small- cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index. It includes approximately 2,000 of the smallest securities based on 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 large cap U.S. equities. It includes 500 leading companies. MSCI EAFE® Index is an unmanaged, market -weighted index of companies in developed markets, excluding the U.S. and Canada. The MSCI EAFE Index net returns reflect the reinvestment of income and other earnings, including the dividends net of the maximum withholding tax applicable to non-resident institutional investors that do not benefit from double taxation treaties. MSCI uses the maximum tax rate applicable to institutional investors, as determined by the companies’ country of incorporation. Source: MSCI. 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.
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.
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 09/30/15, First American Financial Corp. constituted 4.2% of Ariel Appreciation Fund; J.M. Smucker Co. 4.3%; Bristow Group Inc. 2.9%; Kennametal Inc. 4.1%; and Progressive Corp. 1.1%. 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 Appreciation Fund.
