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 September 30, 2019 the average annual returns of Ariel Fund (investor class) for the 1-, 5-, and 10-year periods were -7.17%, +6.64%, and +11.44%, respectively. For the year ended September 30, 2018, the Fund’s Investor Class shares had an annual expense ratio of 1.01%.
Quarter Ended September 30, 2019
Mixed economic data, escalating trade tensions, political turmoil and rising concerns related to a broad slowdown in the global economy continue to weigh on sentiment across markets. It was a quarter that saw the Fed cut interest rates twice and one in which the yield curve inverted for the first time in over a decade, signaling to some that a recession is imminent. Large cap issues outperformed their small cap brethren and U.S. equity markets turned decidedly defensive, as Utilities, Real Estate and Consumer Staples led the pack. Meanwhile, international equities struggled, as a strong U.S. dollar, uncertainties surrounding Brexit and cooling economic momentum pressured earnings growth abroad. Ariel Fund declined -3.28% during the quarter, trailing the Russell 2500 Value Index and the Russell 2500 Index, which returned +0.13% and -1.28%, respectively.
Several stocks in the portfolio delivered strong returns in the period. Alternative asset manager, KKR & Co., Inc. (KKR, Financial) traded +6.78% higher as the company’s financial results continue to highlight strong underlying fundamentals. KKR has also simplified its public reporting with a focus on distributable earnings as its primary metric. In our view, simplified reporting along with the company’s conversion to a corporation from a partnership has broadened investor appeal, while attracting more long-term oriented shareholders.
Moreover, title insurer, First American Financial Corporation (FAF, Financial) advanced +10.66% on strong earnings. Low interest rates continue to strengthen the purchase market, drive substantial growth in refinance activity and sustain a healthy commercial market. Although the anticipated reduction in the Fed funds rate will impact investment income, FAF’s scale advantages and operating leverage position the company to continue delivering strong financial results and intrinsic value growth in the months ahead.
Waste management services provider, Stericycle, Inc. (SRCL, Financial) was another contributor in the quarter increasing +6.66%. Despite mixed earnings results and a downward adjustment in full year financial guidance, management outlined early progress on its objectives to increase sales, improve profitability and reduce costs. Looking ahead, we continue to 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.
Alternatively, other holdings weighed on performance. Television broadcaster and magazine advertiser, Meredith Corporation (MDP, Financial) declined -32.54% in the quarter following a material reduction in financial guidance for full year 2020, which left investors struggling to reconcile the expected cost synergies from the TIME acquisition. While we acknowledge the challenging fundamentals in its businesses, we believe MDP’s profitable local television stations provide a margin of safety at today’s valuation level.
Additionally, producer and supplier of sand, U.S. Silica Holdings, Inc. (SLCA, Financial) traded down -24.83% after the company lowered its near term earnings outlook. Specifically, management disclosed energy markets have softened in West Texas, driven by a combination of budget exhaustion and oversupply of sand resulting in pricing pressure and margin degradation. While investors overly focus on this region, it represents ~50% of total demand for silica in the oil and gas industry. The company also noted its less volatile Industrial Segment—a key component of our investment thesis, accounting for roughly 40% of SLCA’s total EBITDA—remains strong and tracking well with previously articulated expectations. Furthermore, we continue to view the positioning of SLCA’s Sandbox Logistics business to be favorable. Taken together with the company’s stable balance sheet, we believe SLCA is well positioned from a risk/reward standpoint.
Lastly, owner and operator of regional sports and entertainment networks, MSG Networks, Inc. (MSGN, Financial) decreased -21.79%, following an acceleration of reported subscriber losses across Cable, Telco and Satellite video distributors in the quarter. Shares have also been negatively impacted by the lower than expected multiple paid by the Sinclair Broadcast Group, Inc. (SBGI) for the regional sports networks (“RSNs”) included in Walt Disney Company’s (DIS) forced sale of certain 21st Century Fox assets. Management took advantage of the recent weakness in shares and launched a modified Dutch auction, repurchasing ~20% of total shares outstanding. At current levels, MSGN is trading at a -38% discount to our estimate of its private market value.
While we did not initiate any new positions, we successfully exited several positions in the quarter. Manufacturer and supplier of workplace safety products Brady Corporation (BRC, Financial), sports and entertainment business The Madison Square Garden Co. (MSG, Financial) and provider of decision management solutions Fair Isaac Corporation (FICO, Financial) all reached our estimate of private market value. Meanwhile, we sold out of leading supplier of circuit protection products Littelfuse, Inc. (LFUS, Financial) to pursue more compelling opportunities.
We remain cautiously optimistic that slowing yet steady U.S. economic and corporate earnings growth will continue to generate positive returns for quality companies with strong balance sheets in this late-cycle environment. That said, shortterm corrections and market volatility are expected in the nearterm—be it from profit taking, corporate earnings swings, elevated corporate debt leverage, trade policy or geopolitical factors. And while meaningful to current market sentiment and conversation, we view these uncertainties and risks as shortterm 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 09/30/19 KKR & Co., Inc. constituted 5.20% of Ariel Fund; First American Financial Corporation 3.00%; Stericycle, Inc. 3.70%; Meredith Corporation 1.80%; U.S. Silica Holdings, Inc. 2.40%; and MSG Networks, Inc. 2.90%. 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.
