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 Focus Fund rose +3.65%, just behind the Russell 1000 Value Index’s +4.58% return, but ahead of the +2.46% rise of the S&P 500 Index.
Some of our holdings performed well during the quarter. Gold miner Barrick Gold Corp. (ABX, Financial) jumped +57.40% as the price of gold continued to rise. Specifically, gold rose from approximately $1,220 to $1,320 over the course of the quarter. The jump proved big for gold miners as their product jumped in price but their costs remained stable. Barrick remains the biggest and, we think, the best gold miner. In addition, cardiovascular muscle devices maker St. Jude Medical, Inc. (STJ, Financial) popped +42.39% after a takeout offer. Specifically, Abbott Laboratories (ABT, Financial) offered $ 46.75 in cash and 0.9 shares of Abbott stock for each share of St. Jude. The stock jumped more than 25% on the news of the offering.
Other holdings experienced a short-term struggle. Powertrain expert BorgWarner Inc. (BWA, Financial) returned -22.83% since we purchased it in February after lowering multi-year expectations. Although the company’s growth over the next couple of years may not be as strong as previously expected, it continues to grow. Plus its long-term prospects are excellent. The market continues to worry over the emergence of all-electric vehicles. Yet we believe BorgWarner still has a huge position in traditional as well as hybrid vehicles, which together, we think, will likely constitute a vast majority of the market for years to come. Moreover, it is not simply an American company but a global player. We continue to think the company’s present is solid and its future very bright. Also, private equity group KKR & Co. L.P. (KKR, Financial) declined -15.00% due to a soft earnings report combined with Brexit fears. The company reported a loss of -$0.65 per share, well below consensus of -$0.34 per share. The key reason for the miss was an unfavorable mark-to-market on the balance sheet, largely due to its First Data Corp. (FDC) holding. Then, as Brexit occurred toward the end of the quarter, KKR was one of the hardest-hit stocks in the financial sector. We think the short-term earnings report and the overreaction to a political shift do little to harm the company’s long-term value.
During the second quarter, we did not initiate any positions in Ariel Focus Fund, but we sold our shares of Chesapeake Energy Corp. (CHK, Financial) in order to pursue more compelling 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.
As of 6/30/16, Barrick Gold Corp. constituted 4.1% of Ariel Focus Fund; St. Jude Medical, Inc. 4.2%; BorgWarner Inc. 3.0%; KKR & Co. L.P. 3.7%; and Chesapeake Energy Corp. 0.0%. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Focus Fund.
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. 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. Index returns reflect the reinvestment of income and other earnings. Indexes are unmanaged, and investors cannot invest directly in an index.
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 equity stocks is risky and subject to the volatility of the markets. Investing in small and mid cap companies is riskier and more volatile than investing in large cap companies. The intrinsic value of the stocks in which the portfolio invests may never be recognized by the broader market. Ariel Focus Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment.
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 Focus Fund (Investor Class) for the 1-, 5- and 10-year periods were -8.14%, +6.43% and +4.31%, respectively. As of September 30, 2015, Ariel Focus Fund’s Investor Class had an annual net expense ratio of 1.00% and a gross expense ratio of 1.37%. 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, 2017. The Expense Cap prior to February 1, 2014 was 1.25% for the Investor Class. Performance data current to the most recent month-end for Ariel Focus Fund may be obtained by visiting our website, arielinvestments.com.
