Quarter Ended June 30, 2016
For the second quarter in a row, investors will likely remember the harrowing ride better than the end result. That is, domestic stocks posted solid gains and foreign shares had relatively mild losses. In the meantime, however, there was Brexit. On June 23, 2016 the British people shocked the world by voting for the United Kingdom to exit the European Union—an enormously complex and economically risky decision. As you know, the market hates uncertainty. And so in response, foreign stocks plummeted - 10%, small caps dove -7%, and large caps sank -5%. But once investors fully digested the news, stocks jumped back up—nearly erasing their losses in the U.S. Overseas the short-term damage from Brexit still showed; the financial-heavy value indexes significantly lagged the core and growth indexes. In the end, U.S. value fare outpaced growth stocks for the second quarter in a row—definitively ending a very long run of outperformance from the growth side.
This quarter, Ariel Fund fell -1.98%, behind the Russell 2500 Value Index’s +4.37% gain, as well as the +4.31% rise of the Russell 2000 Value Index.
Some of our holdings performed well during the quarter. High-quality industrial sand producer U.S. Silica Holdings, Inc. (SLCA, Financial) surged +52.01% as oil prices recovered.
Specifically, the price of crude oil moved from approximately $35 to $52 before settling back. This move gave investors confidence that oil and gas producers, U.S. Silica’s core customer base, will remain big customers of the firm. We continue to see Silica as having a significant logistical advantage over peers in its crucial niche. In addition, credit specialist Dun & Bradstreet Corp. (DNB, Financial) rose +18.67% after a strong earnings report. After some disappointing numbers in 2015, Wall Street lost faith that the company would get back to its traditional growth rates. This quarter revenues were strong in the U.S., margins were materially better than expected, and so the adjusted earnings per share hit $1.18 (well above the $0.95 consensus). We think Dun & Bradstreet has a solid plan to keep growing, so we plan to remain patient—as we have been all along.
Other holdings experienced a short-term struggle. Asset manager and transaction advisor Lazard Ltd (LAZ, Financial) fell -22.44% after a weak earnings report. Specifically, the company reported adjusted quarterly earnings of $0.50 per share, short of the consensus $0.65 expectation. Revenues were a bit light, while a higher compensation ratio drove the bulk of the miss. In addition, there were net outflows of $361 million in the quarter. We continue to believe the company has a considerable advantage in the crucial emerging markets investment niche. Also, helicopter services company Bristow Group Inc. (BRS) returned - 39.41% due to uncertainty in its business. As you know, oil prices increased more than +25% over the course of the quarter—which marginally improves its business in the intermediate term. Yet the market reacted poorly to its quarterly earnings report: it earned $0.13 per share versus the consensus of $0.55. Plus, management declined to give guidance for its oil and gas segment. While earnings are temporarily constrained we think the long-term opportunity remains sound.
During the second quarter, we added media company Viacom, Inc. (VIAB, Financial) to Ariel Fund. While acknowledging investor concerns toward the cable business model stemming from changing media consumption patterns and technology platforms, we view Viacom as an underappreciated security in the market. Also a current holding in Ariel Appreciation Fund, we believe Viacom’s content will provide attractive economics regardless of the distribution medium. We sold our shares of long- term holding Gannett Co. Inc. (GCI, Financial) in order to pursue better opportunities.
All things considered, our outlook has remained stable over the course of the quarter. In the U.S., we think very little has changed. The economy continues its slow-growth progress, and the market largely reflects that reality. So we remain confident, seeing pockets of opportunity as well as areas that seem a bit expensive. Overseas, risks are clearly higher. In Europe there is likely turmoil as governments begin revamping trade agreements and businesses adjust to a European Union without Great Britain. On the other hand, there is certainly a chance that another referendum will overturn the June 23rd vote and shred all the planned changes. The next-largest foreign risk remains the same: China‘s economy continues to show signs of trouble. Still, in foreign markets we see pockets of opportunity and with the greater potential for change there is a corresponding set of potential opportunities.
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.
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 Fund 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 June 30, 2016, the average annual total returns of Ariel Fund (Investor Class) for the 1- , 5 - and 10-year periods were -10.13%, +8.65% and +6.22%, respectively. The Fund’s Investor Class shares had an annual expense ratio of 1.02% for the year ended September 30, 2015. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com.
