2021 marked another historic year for markets. The S&P 500 Index and MSCI ACWI delivered their third straight year of double-digit gains sending the major indices to record their best three-year performance since 1999.
Stocks overcame numerous headwinds including a resurgence in COVID cases, rising inflation, supply chain challenges, labor shortages and central bank tapering. While we expect volatility to remain elevated, we believe investors focused on underlying long- term business fundamentals will likely be rewarded. Against this backdrop, Ariel Fund traded +3.56% higher in the quarter, trailing both the Russell 2500 Value Index’s gain of +6.36% and the Russell 2500 Index, which returned +3.82%.
Several stocks in the portfolio had strong returns in the quarter. Alternative asset manager, KKR & Co. L.P. (KKR, Financial) advanced following another sequential quarter of solid fundamentals, highlighted by strong transaction fee and fundraising volumes as well as realized investment income. Additionally, the firm reached a new record for asset deployment across both private and public markets. We continue to like KKR’s fundraising outlook and improved visibility in carry and investment income.
Branded home improvement and building products manufacturer Masco Corporation (MAS, Financial) also traded higher following its fourth quarter of year-over-year double-digit sales growth. MAS is effectively navigating supply chain challenges while implementing pricing and cost productivity actions to offset persistent inflation. Management also stepped up its capital deployment strategy in the quarter through the use of dividends and share repurchases. Near term, we believe MAS is well positioned to capitalize on growing interest in do-it -yourself home enhancement. Going forward, we expect the company to enhance its operating profitability, as it continues to benefit from scale, technological know-how and the positioning of its supply chain.
Additionally, title insurer, First American Financial Corporation (FAF, Financial) delivered another excellent quarter, highlighted by higher core title premium revenues resulting from record commercial and agency contributions. Despite a decline in refinancings, title margins were strong, earnings exceeded consensus expectations and FAF’s venture investment arm began to pay dividends. Management reiterated confidence in their outlook for the housing market and consistent with that view, stepped up share repurchase activity. Despite the stock’s recent strength, we believe investors are overly concerned about the impact of rising interest rates on the ongoing housing recovery and continue to underappreciate FAF’s scale, operating leverage and investment portfolio amidst the post-pandemic economy.
Alternatively, several positions weighed on performance during the period. Shares of leading entertainment company ViacomCBS Inc. (VIAC, Financial) traded lower following theannouncement of a rise in content and marketing expenses for new streaming programming. Price action on this news runs counter to the company’s strong business fundamentals and its strengthened balance sheet following the sale of non-core businesses and properties. VIAC’s fresh array of global content continues to drive subscriber momentum worldwide across its digital streaming services as well as market expansion. In our view, premium video content is the most valuable part of the media industry. Based on our sum of the parts analysis, VIAC is currently trading 50% below our estimate of private market value. At today’s valuation, we believe VIAC’s risk/reward is skewed sharply to the upside.
Global leader in for-profit education, Adtalem Global Education (ATGE, Financial) also declined as top and bottom-lineresults missed expectations in the period. Student enrollment decreased, particularly in nursing, largely due to COVID-related headwinds in ATGE’s post-licensure programs. And yet, management reiterated Fiscal 2022 full year revenue and earnings guidance and remains confident in the opportunity ahead. While investors remain skeptical of the near-term backdrop, we believe ATGE is on the path to be number one in undergrad and graduate nursing enrollment in the U.S. and the largest producer of African-American MDs, PhDs and nurses in the country.
Lastly, professional football club operator Manchester United Plc. (MANU, Financial) modestly weighed on relative returnsin the period, following the sale of some shares in the secondary market by the Glazer Family. While the pandemic has been a headwind for the stock, this iconic football club sports a global following north of 1 billion fans and plays in the English Premier League (EPL), the most watched professional sports league in the world. We expect MANU to continue to leverage its global brand to drive a larger revenue base enabling the acquisition of top talent to field competitive teams and further monetize its brand through sponsorships and media rights. Looking ahead, we view the near and long-term outlook for MANU to be attractive.
We initiated two new positions in the quarter. We purchased shares of leading supplier of residential thermal, comfort and security solutions, Resideo Technologies, Inc. (REZI, Financial). In our view, the company’s best-in -class brand andvast distribution network create a narrow moat around the business resulting in high market share and attractive margins across its product portfolio. While the company has struggled to find its footing since being spun-out of Honeywell in 2018, we see early evidence that the new management team’s long-term strategic vision is both achievable and not yet being embraced by investors. We view this as an opportunity to own a niche business, well positioned to benefit from the ongoing housing recovery and a secular preference for more connected smart home solutions.
We also added differentiated casino and entertainment operator, Boyd Gaming Corporation (BYD, Financial), which derives the majority of its revenue from high loyalty and repeat customer base. BYD also owns a minority position in online daily fantasy sportsbook FanDuel. Throughout the pandemic, the company focused on improving operations to permanently lower its expense structure. These initiatives have resulted in margin expansion, strong free cash flow, and accelerated debt repayments. While we expect margins to decline somewhat from currently elevated levels, we believe the market is underestimating the earnings power of the company.
On the sell side, we successfully exited our positions in television broadcaster and magazine publisher, Meredith Corporation (MDP, Financial) as well as America’s largest ski resortoperator Vail Resorts, Inc. (MTN, Financial). Both holdings surpassed our estimate of private market value.
Although uncertainty surrounding new COVID-19 variants and supply chain shortages present risks on a go-forward basis, we believe elevated valuations, rising inflation and less accommodative monetary policy should be top of mind for investors. The best offense is often a good defense. Ignoring market noise and searching instead for quality companies with dominant franchises, capable management teams and robust balance sheets should help insulate on the downside. Meanwhile, we remain cautiously optimistic the post- lockdown recovery will continue, albeit at a slower pace, due to positive corporate earnings growth expectations and improving consumer confidence, particularly if the evolution of less severe variants crowd out the more virulent strands. Looking ahead, we firmly believe the dedicated patient investor that stays the course and consistently owns differentiated businesses at reasonable prices will deliver strong returns over the long run.
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.
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, 2021 the average annual returns of Ariel Fund (investor class) for the 1-, 5-, and 10-year periods were +30.36%, +12.33%, and +14.37%, respectively.
