2022 was a rough year for markets, with nearly every major asset class posting negative returns. Equities logged their biggest declines since the global financial crisis, bonds were hit by a historic sell-off and speculative markets, like cryptocurrencies and so-called ‘meme’ trades imploded. Persistently high inflation, escalating geopolitical tensions in Russia/Ukraine, energy-price shocks, supply bottlenecks and aggressive central bank tightening continue to weigh on consumer and business confidence. Markets, however, are forward looking and much of the bad news is probably already priced in. As such, we deem a mild recession in the U.S. to be more likely than a Fed-induced hard landing. Against this noisy backdrop, we believe active stock pickers steeped in fundamentals are being presented an opportunity to purchase downtrodden shares of quality companies whose value should be realized over the long term. Against this backdrop, Ariel Fund advanced +12.18% in the quarter, outperforming both the Russell 2500 Value Index and the Russell 2500 Index, which returned +9.21% and +7.43%, respectively.
Several stocks in the portfolio had strong returns in the quarter. Professional football (soccer) club operator Manchester United Plc. (MANU, Financial) traded higher on an announcement the Glazer Family is open to exploring strategic alternatives, including a full or partial sale of their stake. 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. We also believe MANU’s commercial opportunity for global partnerships, sponsorships and media rights remains robust. We view the near and long-term outlook for MANU to be attractive.
Boutique asset manager, Affiliated Managers Group, Inc. (AMG, Financial) also advanced in the quarter on robust earnings. While global equity and quantitative outflows continue to moderate, AMG is experiencing strong investment performance within the alternatives segment as well as generating higher performance fees across its diversified set of strategies. Looking ahead, management remains excited about its pipeline of new investments in secular growth areas such as private markets, dedicated ESG strategies, liquid alternatives and wealth management. Meanwhile, AMG continues to take advantage of the company’s low valuation, actively retiring 25% of AMG’s shares outstanding since 2019.
Additionally, shares of oil services company, Core Laboratories NV (CLB, Financial) advanced in the period on solid top and bottom-line results and a subsequent increase in full year guidance. These results were driven by steady activity in the U.S. and an uptick in international markets, illustrating the operational leverage within its global, asset-light business model. CLB also continues to pay down debt with free cash flow generation. The ongoing geopolitical conflict between Russia and Ukraine, as well as associated European and U.S. sanctions, continue to disrupt the business and create near-term uncertainty, however CLB is seeing progress in both onshore and offshore activity across its global operations. We have conviction in the management team’s long history of delivering strong operating results, robust free cash flow and returning capital to shareholders.
Alternatively, leading entertainment company, Paramount Global (PARA, Financial) traded lower on mixed earnings results. Market share gains in streaming and strength in filmed entertainment were partially offset by weakness in linear television, advertising and affiliate subscription fees. Nonetheless, PARA’s fresh array of global content is driving subscriber momentum worldwide across its direct-to-consumer platform with global subscriptions reaching nearly 67 million active users. Additionally, Paramount Pictures opened six #1 films in a row, with Top Gun Maverick becoming the fifth highest grossing domestic movie of all time. While we acknowledge advertising headwinds and investments will continue to weigh on cash flow, we believe PARA’s long-term opportunity in streaming and the value of its proprietary content remain meaningfully underappreciated. At today’s valuation, we view PARA’s risk/reward is skewed sharply to the upside.
Leading supplier of residential thermal, comfort and security solutions, Resideo Technologies, Inc. (REZI, Financial) also traded lower in the period following an earnings miss and a subsequent reduction in full year guidance. Although end-customer demand remains steady, the company experienced a slowdown in orders across channel partners, as distributors reduced inventory levels due to macro uncertainty. Inflation, semi-conductor shortages, Fx headwinds and lower factory productivity also pressured margins. In our view, the company’s best-in-class brand and vast distribution network create a narrow moat around the business resulting in high market share across its product portfolio. We believe REZI’s earnings potential is underappreciated and will be driven by a secular preference for more connected smart home solutions.
Finally, leading global manufacturer of power generation equipment Generac Holdings, Inc. (GNRC, Financial) underperformed in the quarter following an earnings miss due to headwinds in its solar business and a near-term inventory issue that should be worked through in the coming quarters. Subsequently, management announced a downward revision to full year guidance. In our view, GNRC’s unmatched distribution network and product portfolio enjoys strong brand advantages, creating a wide moat for this niche business which commands a 75% market share in the North American residential market. Historically, growth has been limited due to a lack of awareness around the benefits of having a home standby generator, as well as its high price point. However, elevated power outage events, both weather-related and due to aging infrastructure, have tipped the scales of awareness in both the residential and commercial markets. These heightened consumer sensitivities should result in a long-runway of market penetration, margin expansion and free cash flow generation.
Also in the quarter, we initiated a new position in alternative asset manager, Carlyle Group (CG, Financial). CG’s competitive advantages include a notable 35-year track record of investment performance across various economic and financial market conditions, diversified product offerings and long-tenured client relationships across five continents. CG has underperformed its peers and the S&P 500, presenting us with a unique opportunity to acquire shares of what we believe to be a highly scalable business with attractive fundamentals and healthy fundraising momentum.
On the sell side, we successfully exited manufacturer and developer of laboratory equipment and biological testing, Bio-Rad Laboratories Inc. (BIO, Financial) on valuation and although bittersweet, we also sold out of long-time holding KKR & Co. (KKR, Financial), as its growth in market capitalization surpassed the upper limit of Ariel’s small/mid cap value range in the quarter.
Decades-high inflation, a looming energy crisis, geopolitical conflict, slowing economic growth and the potential for further Fed tightening continues to fuel recessionary fears. As we recently wrote in The Wall Street Journal, although U.S. consumers are still buying, their confidence is waning, as prices and escalating wages remain largely unaffected by the rate hikes meant to contain them. Corporate earnings are also beginning the painful reset to reflect today’s economic reality. And yet, there are reasons for optimism. At the top of the list is the fact that much of the bad news is out and probably priced into the stock market already. Moreover, balance sheets of U.S. financial institutions and households are in vastly better shape than prior downturns. Looking forward, there may be more shoes to drop and markets can fall further. Still, our 40 years of patient investing during traumatic environments spanning the crash of 1987, the dot-com era, the global financial crisis, the U.S. debt downgrade and the Covid plunge have taught us bear markets create ripe buying opportunities for long-term investors. Once valuations stabilize, we expect the patient investor will be rewarded as the bull charges forward once again.
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, 2022, the average annual returns of Ariel Fund (investor class) for the 1-, 5-, and 10-year periods were -18.82%, +4.62%, and +9.96%, respectively.
