Ariel Appreciation Fund commentary for the second quarter ended June 30, 2016.

H/T Dataroma

For the second quarter in a row, investors will likely remember the harrowing ride better than the end result. That is, domestic stocks posted solid gains and foreign shares had relatively mild losses. In the meantime, however, there was Brexit. On June 23, 2016 the British people shocked the world by voting for the United Kingdom to exit the European Union—an enormously complex and economically risky decision. As you know, the market hates uncertainty. And so in response, foreign stocks plummeted -10%, small caps dove -7%, and large caps sank -5%. But once investors fully digested the news, stocks jumped back up—nearly erasing their losses in the U.S. Overseas the short-term damage from Brexit still showed; the financial-heavy value indexes significantly lagged the core and growth indexes. In the end, U.S. value fare outpaced growth stocks for the second quarter in a row—definitively ending a very long run of outperformance from the growth side.

This quarter, Ariel Appreciation Fund rose +0.28%, behind the Russell Midcap Value Index’s +4.77% rise, as well as the +3.18% return of the Russell Midcap Index.

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Some of our holdings performed well during the quarter. Cardiovascular muscle devices maker St. Jude Medical, Inc. (STJ) popped +42.39% after a takeout offer. Specifically, Abbott Laboratories (ABT) offered $46.75 in cash and 0.9 shares of Abbott stock for each share of St. Jude. The stock jumped more than 25% on the news of the offering. In addition, insurance company AFLAC Inc. (AFL) advanced +14.96% on an earnings beat. The company’s revenues and earnings beat the Street estimates. The company reported earnings per share of $1.73 versus the Street’s expectation of $1.63. In addition, the company repurchased $600 million of its stock, well on its way toward the $1.4 billion repurchase goal this year. We continue to think the company has a powerful economic moat1 and is smartly taking advantage of it.

Other holdings experienced a short-term struggle. Helicopter services company Bristow Group Inc. (BRS) returned -39.41% due to uncertainty in its business. As you know, oil prices increased more than +25% over the course of the quarter—which marginally improves its business in the intermediate term. Yet the market reacted poorly to its quarterly earnings report: it earned $0.13 per share versus the consensus of $0.55. Plus, management declined to give guidance for its oil and gas segment. While earnings are temporarily constrained we think the long-term opportunity remains sound. Also, asset manager and transaction advisor Lazard Ltd (LAZ) fell -22.44% after a weak earnings report. Specifically, the company reported adjusted quarterly earnings of $0.50 per share, short of the consensus $0.65 expectation. Revenues were a bit light, while a higher compensation ratio drove the bulk of the miss. In addition, there were net outflows of $361 million in the quarter. We continue to believe the company has a considerable advantage in the crucial emerging markets investment niche.

During the second quarter, we added two new positions and exited two positions in Ariel Appreciation Fund. We purchased leading global auto supplier BorgWarner Inc. (BWA), which focuses on developing leading powertrain technologies that improve fuel economy, emissions and performance. BorgWarner’s earnings power and growth have been underappreciated in the market, yet it has been a strong player in the evolution of hybrid vehicles and has made acquisitions when it needed additional technology. We purchased PrivateBancorp, Inc. (PVTB) towards the end of the quarter. We think the market punished the stock quite harshly this year and, in the wake of Brexit, we became convinced it was oversold. It represents an unusual case: very shortly after we began buying the stock, the company announced it was being acquired—therefore we stopped purchasing the stock and it did not become a full position. We sold Contango Oil & Gas Co. (MCF) and Newell Rubbermaid Inc. (NWL) to pursue more compelling opportunities.

All things considered, our outlook has remained stable over the course of the quarter. In the U.S., we think very little has changed. The economy continues its slow-growth progress, and the market largely reflects that reality. So we remain confident, seeing pockets of opportunity as well as areas that seem a bit expensive. Overseas, risks are clearly higher. In Europe there is likely turmoil as governments begin revamping trade agreements and businesses adjust to a European Union without Great Britain. On the other hand, there is certainly a chance that another referendum will overturn the June 23rd vote and shred all the planned changes. The next-largest foreign risk remains the same: China‘s economy continues to show signs of trouble. Still, in foreign markets we see pockets of opportunity and with the greater potential for change there is a corresponding set of potential opportunities.

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