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 is often concentrated in fewer sectors than its benchmarks, 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. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com. For the Period ended December 31, 2019 the average annual returns of Ariel Fund (investor class) for the 1-, 5 -, and 10-year periods were +24.67%, +6.69%, and +11.54%, respectively. For the year ended September 30, 2019, the Fund’s Investor Class shares had an annual expense ratio of 1.02%.
Quarter Ended December 31, 2019
U.S. stocks closed 2019 with their best annual performance in six years and international equities rallied higher, as an improving global economic outlook, easing trade tensions and a dovish fed indicated to investors that the bull market still has room to run. While growth trounced value for most of the year, interesting shifts occurred in the fourth quarter. Small cap issues outperformed their large cap brethren and investors increased their appetite for risk, favoring emerging markets over U.S. equities. Ariel Fund advanced +8.78% during the quarter, outperforming both the Russell 2500 Value Index and the Russell 2500 Index, which returned +7.07% and +8.54%, respectively.
Several stocks in the portfolio delivered strong returns in the period. Bar code manufacturer Zebra Technologies Corp. (ZBRA, Financial) traded +23.78% higher on solid earnings results. Sales growth across the North America and EMEA regions, offset a softer spending environment in China. Operational discipline and cost efficiencies drove margin expansion and ZBRA delivered record earnings per share in the quarter. The company continues to win business across products and verticals with a broad range of leading enterprises, including a recently announced multi-year agreement with the United States Post Office. We believe there is still more upside to come. Specifically ZBRA’s nascent opportunity in the healthcare space, the deferment and runway of Android refresh cycles, as well as the potential to create value through capital allocation. As evidenced by our heavy weighting in the portfolio, we continue to like everything about this story.
Moreover, waste management services provider Stericycle Inc. (SRCL, Financial) jumped +25.29% over the period. The company is executing well against its multi-year strategy to increase sales, improve profitability and reduce costs. Quarterly performance highlights include organic top line growth across the core businesses, an improvement in Adjusted EBITDA, strong free cash flow generation and the largest quarterly net debt reduction SRCL has made in two years. The company is also making progress on its portfolio rationalization efforts, as it divested three non-core businesses during October. Looking ahead, we view SRCL as a solid franchise with stable long-term growth prospects, including margin expansion opportunities and strong free cash flow generation resulting from ongoing strategic transformation initiatives.
Leading commercial real estate services firm Jones Lang LaSalle (JLL, Financial) was another contributor in the quarter, trading +25.52% higher on better than expected earnings results. Strong organic growth, along with robust performance from JLL’s recent acquisition of HFF – leading provider of capital market transaction services to the United States and Western Europe – drove double digit increases across fee revenue, adjusted EBITDA, and adjusted EPS. With a 5% increase in semi-annual dividends and a new $200 million share repurchase program announced this quarter, we remain optimistic about JLL’s continued value proposition for shareholders.
Alternatively, other holdings weighed on performance. Producer and supplier of sand, U.S. Silica Holdings, Inc. (SLCA, Financial) declined -34.97% in the quarter. Weakened demand across the energy patch, including markets in West Texas have driven an oversupply of sand resulting in pricing pressure and margin degradation. While a key component of our investment thesis in SLCA continues to be driven by its Industrial segment, we underestimated the impact that weakness in oil and gas could have on the cost structure of the Industrial business. Looking ahead, SLCA remains in a solid position from a liquidity perspective. They do not have any maturities due until 2025, and the balance sheet and cash on hand remain sound. At current trading levels, we believe SLCA is well positioned from a risk/reward standpoint.
Additionally, leading manufacturer of testing systems and sensor technologies, MTS Systems Corp. (MTSC, Financial) traded -12.51% lower on mixed quarterly earnings results. While revenue came in ahead driven by growth in the Test & Simulation and Sensors divisions and a new lucrative contract with the U.S. Department of Defense, profitability and EPS fell modestly below consensus. Nonetheless, MTSC ended Fiscal 2019 with momentum, highlighted by record year-end backlog. Looking ahead, we see MTSC as an opportunity to own a niche industry leader undergoing a favorable business mix shift that is well positioned to benefit from industrial innovation, automation, and safety.
Lastly, leading manufacturer of consumer food products, J.M. Smucker Co. (SJM, Financial) declined -4.56% on mixed earnings results. While top line sales were pressured by continuing softness for premium dog food offerings, the company delivered EPS growth ahead of expectations. We believe this performance highlights management’s commitment to maintain financial discipline and strengthen its bottom line. At today’s valuation, we see the risk/reward skewed sharply to the upside.
While we did not initiate any new positions, we successfully exited our position in distributor of solutions for network, security and utility power, Anixter International Inc. (AXE, Financial), as the stock reached our estimate of private market value.
With the S&P 500 Index trading at 19.4x forward earnings and the Russell 2500 Index trading at 17.8x, there is not much room left for multiple expansion. Instead, we expect slowing yet steady U.S. economic fundamentals and mid-single digit corporate earnings growth will continue to generate positive returns for quality companies with strong balance sheets in this late-cycle environment. Given our “slow and steady” approach, we remain confident in our portfolio positioning, especially since our portfolios are trading at a discount relative to both the indices and our own internal estimates of private market value. That said, short-term corrections and market volatility are expected in the near- term—be it from geopolitical factors, trade policy, political events, profit taking, corporate earnings swings or elevated corporate debt leverage. And while meaningful to current market sentiment and conversation, we view these uncertainties and risks as short-term noise within the context of our long-term investment horizon.
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 12/31/19 Zebra Technologies Corp. constituted 4.20% of Ariel Fund; Stericycle Inc. 4.40%; Jones Lang LaSalle 4.00%; U.S. Silica Holdings, Inc. 1.60%; MTS Systems Corp. 2.00%; and J.M. Smucker Co. 3.20%. 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.
