Recently, we were pleased to read a Morningstar FundInvestor article entitled, “Risk Off,” written by Director of Fund Research and Editor Russel Kinnel. The piece discusses funds with betas and standard deviations that have fallen the last few years. Kinnel dedicates a paragraph each to six mutual funds with volatility that improved dramatically over the past three years, including our flagship Ariel Fund. He describes Ariel Fund as long having “the profile of being a bit to the cautious side, with fairly stable but low P/E stocks,” and we agree. He then notes that volatility spiked in the Great Recession of 2008-2009 and summarizes the aftermath in positive terms:
Manager John Rogers (Trades, Portfolio) dialed up the firm’s work on balance sheets in an attempt to manage that risk better. The fund’s performance has recovered, but even with this decline in volatility, standard deviation remains on the high side.
We took this opportunity to examine Ariel Fund’s standard deviation history, which we discuss below.
As you know, standard deviation is the classic measurement of volatility. Specifically, it measures how much a fund’s returns differ over the short-term versus its own long-term average. We ran three-year rolling standard deviation figures from January 1, 1987 (shortly after Ariel Fund’s inception) through June 30, 2015. Up until the end of 2007, as Kinnel suggests, Ariel Fund’s median standard deviation was slightly below its category peers and indexes: Ariel Fund, +14.00; Russell 2500 Value Index, +15.20; and the Morningstar Mid-Cap Blend category, +14.42. And yet, it has been more volatile since early 2009.
To the latter point, the FundInvestor article specifically examines the period from mid -2012 to mid-2015, where an interesting wrinkle appears. Kinnel correctly notes that Ariel Fund’s standard deviation drops from 26 to 13 but remains above the mid-blend peer average of 10. In light of its own long -term history, however, Ariel Fund’s drop was from very far above normal to well below normal. Three years ago, Ariel Fund’s standard deviation of 26 was well above its long-term average of 16, and now at 13, it is well below its long-term average. It remains higher than its benchmark and peers only because both the Russell 2500 Value Index and the Mid-Blend category average have fallen to even lower historical levels than their own historical norms. Their current standard deviations are about 66% of their multi-decade averages. To summarize: We all know that volatility was especially high during and after the Great Recession, but few seem to recognize that volatility in U.S. stocks is now remarkably low.
With that, we turn to the truism that Ariel’s global portfolio manager Rupal J. Bhansali noted at a recent conference in Sydney, Australia: “Stability is not always your friend, and volatility is not always your enemy.” Bhansali points out that risk and return are always linked, and in many cases, there is a trade-off between them. It makes sense then to consider risk in light of returns rather than independently. Since the Great Recession, many assets that demonstrate relative or absolute stability have seen valuations rise. And, in our view, somewhat more volatile securities have been cheap relative to intrinsic value and history. Also, over the last three years, Ariel Fund’s volatility has indeed been above that of our peers and benchmarks, but its returns have also been higher. From 6/30/12 – 6/30/15, the Fund has gained +22.94% annually, well above the Russell 2500 Value Index’s +16.99% rise and the Morningstar Mid-Blend category average’s 17.41% return.1
In the big picture, as we see it, Ariel Fund’s standard deviation jumped to abnormally high levels in the crisis and has fallen to an abnormally low level at this point. That fall in volatility also accompanied returns that were well above historical averages and relevant benchmarks. We think shareholders have thus had an attractive experience the past three years: above-average returns with below-average volatility.
1 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. 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, 2015, the average annual total returns of Ariel Fund for the 1- , 5- and 10-year periods were +9.79%, +19.15% and +7.46%, respectively. Ariel Fund’s Investor Class shares had an annual expense ratio of 1.03% for the year ended September 30, 2014. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com.
The opinions expressed are current as of the date of this commentary but are subject to change. The details offered in this commentary do 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 more risky and subject to the volatility of the markets. Investing in small and mid- sized companies is more risky and more volatile than investing in large companies. The intrinsic value of the stocks in which the funds invest 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.
Morningstar, Inc. is a nationally recognized organization that reports performance and calculates rankings for mutual funds. Ariel Fund is classified by Morningstar as a Mid-Blend fund. The source of the data contained in this commentary: ©2015 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
Investors should consider carefully the investment objectives, risks, and charges and expenses before investing. For a current prospectus or summary prospectus which contains this and other information about the funds offered by Ariel Investment Trust, call us at 800-292-7435 or visit our website, arielinvestments.com. Please read the prospectus or summary prospectus carefully before investing. Distributed by Ariel Distributors LLC, a wholly owned subsidiary of Ariel Investments LLC.
Indexes are unmanaged, and investors cannot invest directly in an index. The Russell 2500™ Value Index measures the performance of the small to mid-cap value segment of the U.S. equity universe. It includes those Russell 2500 companies with lower price -to-book ratios and lower forecasted 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.
