What a difference a month makes! As you know, investors and the financial press were worried by the end of September given widespread losses during the third quarter. As we noted in our quarterly commentaries: “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%.” Then, in what must have come as a big surprise to the hand-wringers, October happened. For the single month, the returns of the indexes cited above were: S&P 500 up +8.44%; Russell 2000 up +5.63%; MSCI EAFE up +7.82%. October’s gains do not change the tough returns from January through September, but we think you will agree the 2015 markets look quite different just one month later. Before October, the three broad indexes we watch closely were down significantly in 2015, while the twelve-month numbers were uninspiring. There is a different picture today, as you can see below:
At this point in the year, the large-caps at home and abroad both have modest gains, and U.S. small-caps are off a minor amount. Over the last twelve months, the international and U.S. small-cap returns appear flat to us, with U.S. large-caps up a meaningful amount. That is a much more positive description than anyone could muster just one month ago.
As those who watch closely are aware, Ariel’s domestic portfolios suffered difficult returns in the third quarter of 2015. As of September 30th, all four domestic funds trailed their benchmarks for the year-to-date period and over the preceding twelve months. The table below shows the standardized periods as of September 30th:
Little changed for Ariel International Fund and Ariel Global Fund, which were outperforming their benchmarks for the preceding year; they still are. Unfortunately, the situations for Ariel Discovery Fund and Ariel Focus Fund also remain the same: they continue to lag their benchmarks significantly over the past year. Meanwhile, Ariel Fund and Ariel Appreciation Fund, which suffered in the third quarter, have seen their returns relative to their benchmarks flip from negative to positive. A month ago, both Funds were “laggards” for the one-year period; now both have outperformed their benchmarks. For the year-ended October 31, 2015, Ariel Fund has gained +2.08%, topping its Russell 2500 Value Index benchmark’s -1.06% loss. For the same period, Ariel Appreciation Fund has gained +1.55%, ahead of the Russell Midcap Value Index’s +0.47% return. Simply put, the market hit an inflection point, causing these two funds’ fortunes to turn.
Inflection points are tricky. Nobody really knows when they will occur, including us. As you know all too well, we do not try to “call” the market, or even individual stocks. We will, however, single out individual stocks when we think they are overbought or oversold. We did just that in the most recent quarterly letter for Ariel Fund and Ariel Appreciation Fund, one we entitled “Industrial Revolution.” In it we described three beaten- down industrial companies from our portfolios that our research suggested were bargains: helicopter services provider Bristow Group Inc. (BRS, Financial), chainsaw chain-maker Blount Intl, Inc. (BLT, Financial), and specialized tool manufacturer Kennametal Inc. (KMT, Financial). As of September 30, 2015, for the year-to-date period, Bristow had descended -59.42%, Blount was off -68.30%, and Kennametal had dropped -29.32%. In the month of October, when the market took a breath, Bristow jumped +32.76%, Blount was up +8.98%, and Kennametal gained +12.98%. To be sure, these three stocks remain significant detractors this calendar year for the Funds, but they came off the bottom more strongly and more swiftly than even we expected.
The lesson is relatively simple from our perspective. Market sentiment is often extreme, and it can spin on a dime. For example, pessimism was on the mount throughout the summer, and many cautioned the correction would turn into a full-fledged bear market. Then, all of a sudden, the market turned and the doomsayers got quiet. Attempting to invest by listening to, following or even simply going against sentiment is very difficult or even impossible to do successfully. Instead, at Ariel, we prefer to pay attention to valuation and fundamentals, not market sentiment. That way, we can ignore the crowd whether it is fearful, ebullient or anywhere in between.
The opinions expressed are current as of the date of this commentary but are subject to change. The details offered in this commentary do 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.
Past performance does not guarantee future results. Investing in equity stocks is more risky and subject to the volatility of the markets. Investing in micro-, small - and mid-size companies is more risky and more volatile than investing in large companies. Ariel Focus Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment. The intrinsic value of the stocks in which the portfolios invest may never be recognized by the broader market. Certain portfolios often invest a significant portion of assets in companies within the financial services and consumer discretionary sectors, and their performance may suffer if these sectors underperform the overall stock market. 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, and foreign currencies and taxes. The use of currency derivatives and exchange-traded funds (ETFs) may increase investment losses and expenses and create more volatility. Investments in emerging markets present additional risks, such as difficulties in selling on a timely basis and at an acceptable price.
The Investor Class shares of Ariel Fund and Ariel Appreciation Fund had annual expense ratios of 1.03% and 1.12%, respectively, for the year ended September 30, 2014. As of September 30, 2014, Ariel Focus Fund’s Investor Class had an annual net expense ratio of 1.08% and a gross expense ratio of 1.40%. Effective February 1, 2014, Ariel Investments, LLC, the Adviser, has contractually agreed to waive fees or reimburse expenses (the "Expense Cap") in order to limit Ariel Focus Fund's total annual operating expenses to 1.00% of net assets for the Investor Class through the end of the fiscal year ending September 30, 2016. The Expense Cap prior to February 1, 2014 was 1.25% for the Investor Class. Ariel Discovery Fund’s Investor Class shares had a gross expense ratio of 1.93% and a net expense ratio of 1.33% as of September 30, 2014. Effective February 1, 2014, Ariel Investments, LLC, the Adviser, has contractually agreed to waive fees or reimburse expenses (the "Expense Cap") in order to limit Ariel Discovery Fund's total annual operating expenses to 1.25% of net assets for the Investor Class through the end of the fiscal year ending September 30, 2016. The Expense Cap prior to February 1, 2014 was 1.50% for the Investor Class. As of September 30, 2014, Ariel International Fund’s Investor Class had an annual net expense ratio of 1.29% and an annual gross expense ratio of 4.24%. Effective February 1, 2014, Ariel Investments, LLC, the Adviser, has contractually agreed to waive fees or reimburse expenses (the "Expense Cap") in order to limit Ariel International Fund's total annual operating expenses to 1.25% of net assets for the Investor Class through the end of the fiscal year ending September 30, 2016. As of September 30, 2014, Ariel Global Fund’s Investor Class had an annual net expense ratio of 1.29% and an annual gross expense ratio of 3.70%. Effective February 1, 2014, Ariel Investments, LLC, the Adviser, has contractually agreed to waive fees or reimburse expenses (the "Expense Cap") in order to limit Ariel Global Fund's total annual operating expenses to 1.25% of net assets for the Investor Class through the end of the fiscal year ending September 30, 2016.
As of 09/30/15, Ariel Fund held the following positions referenced: Bristow Group Inc. 2.7%; Blount Intl, Inc. 1.3%; and Kennametal Inc. 3.7%. As of 09/30/15, Ariel Appreciation Fund held the following positions referenced: Bristow Group Inc. 2.9%; Blount Intl, Inc. 0.0%; and Kennametal Inc. 4.1%. As of 09/30/15, Ariel Focus Fund held the following positions referenced: Bristow Group Inc. 0.0%; Blount Intl, Inc. 0.0%; and Kennametal Inc. 3.0%. As of 09/30/15, Ariel Discovery Fund held the following positions referenced: Bristow Group Inc. 1.2%; Blount Intl, Inc. 0.0%; and Kennametal Inc. 0.0%. Ariel International Fund and Ariel Global Fund do not hold positions in any of the companies mentioned. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of the Funds.
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 on the basis of a combination of their market cap and current index membership. 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-to-book ratios and lower forecasted growth values. 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 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected 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-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. 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 ACWI (All Country World Index) IndexSM is an unmanaged, market weighted index of global developed and emerging markets. The MSCI ACWI 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. The S&P 500® Index is the most widely accepted barometer of large-cap U.S. equities. It includes 500 leading companies. Indexes are unmanaged. An investor cannot invest directly in an index.
