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Holly LaFon
Holly LaFon
Articles (10163)  | Author's Website |

John Rogers' Ariel Fund 1st Quarter 2018 Shareholder Letter

Discussion of holdings and markets

Equities started 2018 with a bang, and then the momentum was interrupted as rising concerns over inflationary pressures in the U.S., higher interest rates, and fears of a global trade war triggered increased volatility. As a result, the large-cap S&P 500 Index ended the quarter down -0.76%, the small-cap Russell 2000 Index traded -0.08% lower and the global MSCI EAFE Index declined -1.53%. For the quarter, the Ariel Fund advanced +0.80%, significantly outperforming the Russell 2500 Value Index and Russell 2500 Index, which declined -2.65% and -0.24%, respectively.

The positive results for Ariel Fund were largely driven by strong stock selection within the producer durables and financial services sectors, contributing +149 basis points and +120 basis points, respectively to returns relative to the Russell 2500 Value Index. Bar code manufacturer, Zebra Technologies (NASDAQ:ZBRA) was the top performer within the producer durables sector, delivering +34.09% gain. Broad based demand both geographically and by product end market drove a top and bottom line earnings beat. The company also made significant progress reducing its financial leverage by surpassing the full year debt pay down commitment by more than 50%. Moreover, management issued quarterly and full year 2018 guidance that exceeded consensus estimates. We continue to believe ZBRA remains underpriced relative to its intrinsic value.

Another top contributor within producer durables was innovative test and measurement business, Keysight Technologies, Inc. (NYSE:KEYS), which advanced +25.94% after delivering better than expected revenue and earnings. The beat was driven by strong order growth across its end-markets, including 5G, automotive and energy, semiconductors, aerospace and defense; a faster than anticipated production recovery following the Northern California wildfires. KEYS also announced a $350M share repurchase authorization in the quarter.

Within the financial services sector, real estate expert Jones Lang LaSalle (JLL) advanced considerably in the quarter, posting a +17.26% gain on solid earnings, highlighted by double digit revenue growth, disciplined cost management and strong operating cash flows which contributed to a significant reduction in net debt. These results were achieved while making meaningful progress on their data and technology strategic priorities. With favorable economic conditions and healthy real estate fundamentals in most markets, we believe JLL will continue to benefit from global growth, the outsourcing of real estate services and institutional demand for commercial real estate.

Alternatively, from an attribution perspective, there was not one particular sector that materially underperformed on a relative basis during the quarter. The weakest performer in the portfolio was specialty cutting tool insert maker Kennametal Inc. (KMT), which finished the quarter down -16.65%. We believe this price action runs counter to its strong business fundamentals. KMT is executing on a 3-year strategic plan that will improve economies of scale and generate margin improvement. Furthermore, despite near term adverse effects of tax reform on the company, stronger than anticipated end market demand for products resulted in management raising the adjusted EPS outlook for fiscal 2019.

Local network broadcast TV provider TEGNA, Inc. (NYSE:TGNA) also weighed on quarterly performance, trading down -18.66% as fourth quarter and fiscal 2017 results missed top line expectations due to the absence of cyclical political revenue contributions as well as the digital businesses cars.com and CareerBuilder. TEGNA is now a pure-play TV station operator and largest owner of top four affiliates in the top 25 markets. We believe the company is well positioned for subscription revenue growth as cable, satellite, telecom operators and virtual multichannel providers pay for the right to carry TGNA’s programming. We think network TV remains the most effective medium that has mass reach and the ability to build a brand campaign for national and local advertisers. TGNA is also poised to deliver strong free cash flow in 2018, due to growing retransmission revenues, Super Bowl LII on NBC, XXIII Olympic Winter Games on NBC and political advertising.

Producer and supplier of sand, U.S. Silica Holdings, Inc. (NYSE:SLCA) detracted from performance as well. Shares declined -21.44% as volatility in oil and gas prices have investors questioning the future utilization of drilling rigs if prices remain at lower levels. However, record tons of oil and gas were sold company wide for both the quarter and fiscal 2017. Management also announced the acquisition of EP Minerals, global producer of engineered materials, raising additional concerns about SLCA’s intent to diversify away from being a provider of proppant to the fracking industry. We believe these concerns are overdone, as the company remains well positioned to benefit from underlying demand growth in its end markets and believe SLCA’s scale, distribution capabilities and industrial business are competitive advantages that are underappreciated in the long term value of the business.

During the quarter, we initiated a position in global alternative asset manager Oaktree Capital Group LLC (NYSE:OAK), whose expertise in distressed investments provides exposure to a countercyclical business model. We did not exit any positions in Ariel Fund during the quarter.

Despite higher market volatility, we remain cautiously optimistic that steady economic and corporate earnings growth, as well as U.S. tax reform will boost profitability for many of our domestic holdings. In the meantime, while cyclical pressures on inflation are building, we believe technological innovation presents a considerable headwind. Not to mention, history shows that stocks can still do well in a rising rate environment. With the S&P 500 Index trading at 17.1x forward earnings and the Russell 2500 Index trading at 17.6x, valuations remain below euphoric levels. Given our “slow and steady” approach, we remain confident in our portfolio positioning, especially with our portfolios trading at a discount relative to the indices. Likewise, we continue to be intrigued by the international markets, given low levels of inflation in developed countries, increasing consumer confidence and the gradual normalization of monetary policy. At 14.1x forward earnings, the MSCI EAFE Index trades at a discount relative to its U.S. counterpart, offering a positive backdrop for savvy active managers.

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 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 March 31, 2018, the average annual total returns of Ariel Fund (Investor Class) for the 1-, 5- and 10-year periods were +9.62%, +12.41% and +10.28%, respectively. For the year ended September 30, 2017, the Fund’s Investor Class shares had an annual expense ratio of 1.01%.

About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website


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