There are only a handful of managers that are still at the helm of the funds they founded 30 years ago, and John W. Rogers, Jr. is one of them. The Ariel Fund seeks companies that have the capacity to overcome temporary setbacks while avoiding businesses that are more likely to struggle or face decline.
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What is the history of the fund?
Launched on November 6, 1986, Ariel Fund seeks to invest in small- to mid-cap companies with the potential to consistently outpace the market. We invest when these companies are selling at bargain prices and hold them for the long term. In a nutshell, we are buyers of good businesses but only when they are temporarily out of favor.
We’ve held true to these principles even during major market crises when stocks have unraveled and bubbles have burst. At times, the fund underperformed and some clients began to lose confidence. What appeared to be setbacks, though, were actually periods where we found favorable circumstances and created great opportunities for the fund. By adhering to our core mission and buying targeted stocks while markets and prices were collapsing, the fund recovered each time, delivering above market performance and distinguishing itself from its peers.
For example, when the stock market crashed in 1987, we bought more of our favorite bargains while other investors stayed on the sidelines. This set the fund up for truly great performance in 1988, and I was gratified to be named “Co-Mutual Fund Manager of the Year” by Sylvia Porter’s Personal Finance Magazine.
Another major milestone occurred when the internet bubble was booming. Because we stayed true to our principles and didn’t chase dot-com or technology stocks, we fell behind the market. When that bubble finally burst, though, the fund emerged with stellar performance as we moved into the new century.
Finally, the financial crisis of 2008 was a very trying time in the firm’s history. It was one of the few times we underperformed significantly in a down market, and we lost clients. But, just as we had in 1987, we continued to buy our favorite stocks even as the market collapsed. Though the portfolio didn’t perform well in 2008, we laid the groundwork for a tremendous recovery in 2009. This contributed to the fund’s strong 10-year and 30-year track records.
How do you define your investment philosophy?
Our focus is on small and midsize companies which we believe can grow fast and are inefficiently priced, and we invest in them when they are cheap. Valuation is a principal part of our strategy; typically, we buy relatively low price-to-earnings companies trading at a 40% discount to their private market value (PMV).
Finally, we are long-term investors. The fund’s turnover is usually 20%, which implies the average stock is held for five years, but we’ve owned many stocks for 15 to 25 years.
We invest in companies with a large moat and the ability to maintain that moat over time. Typically, businesses like this generate a lot of cash, have high return on invested capital, and relatively strong balance sheets.
Though catalysts are good to have, they aren’t necessary for us to buy a stock. We remain patient and are willing to wait for the markets to understand the quality of the businesses, management teams, and balance sheets we have invested in.
What is your investment process?
We look for differentiated companies with strong brands/franchises, strong cash flows, low debt, high quality products or services, significant barriers to entry (moats) and low reinvestment requirements. We don’t feel a need to be invested in every industry. Typically, we avoid industries/sectors that are heavily cyclical, commodity-oriented, or lacking a moat. With 40 stocks or fewer, our portfolios are quite concentrated, which substantially narrows the universe of 3,000. We invest in companies we understand extremely well and which we enjoy reading about and studying.
In-depth sector and industry expertise informs each investment decision. Our portfolio managers and research analysts evaluate companies within a wellestablished “circle of competence”—industries where we are truly experts. Our in-depth industry knowledge, in turn, helps uncover investment ideas others may have overlooked.
A senior analyst covers a sector and tracks all the companies within it, ranking companies from top to bottom, using a valuation-based ranking system that’s an important part of our discipline and process. Each ranking, in turn, is based upon a company’s discount to its PMV.
Each analyst knows their sector extremely well: they know which companies are the highest-quality and which ones are the weakest; the lowest-priced and most expensive. We wait for the “perfect pitch,” meaning we want to invest in high quality businesses selling at bargain prices. This can happen over time or suddenly—with one bad announcement, a stock we’ve always wanted to own can become substantially cheaper.
We read extensively, monitor computer-generated screens and meet with industry experts while also staying abreast of former holdings that can become candidates for repurchase. A large part of my job as lead portfolio manager is to constantly search for fresh names and new ideas and learn about their businesses and sectors.
Studying our peers and competitors is also important, as we find creative ideas that are out of favor with other managers. We analyze what they own and why, looking not only at their winners, but also at those which have underperformed over the last six, 12, or 18 months.
Finally, we’ve established a strong network of people who understand the types of companies we are searching for, and the sectors in which we invest. We also often talk and meet with CEOs and industry leaders.
Does your process involve talking to management?
We look for management teams that are direct and honest about their company’s strengths and weaknesses, and don’t have an interest in those that are misleading or make excuses for underperformance.
Beyond that, it’s critical that management understands capital allocation decisions – stock buyback versus dividend versus acquisitions, the use of the balance sheet, and their capital markets. Our goal is to understand the thought process behind the decisions management makes. Our strategic questioning of company management teams enables us to determine critical issues affecting companies. So yes, we’re regularly on the phone with management teams.
Every quarter, we talk to management about their strategic plan and the progress they are making toward it. We track if they’ve fallen off plan, and if so, discuss whether this is because they don’t believe in it any longer.
Can you describe your investment process with an example?
A great example is Nielsen Holdings plc (NLSN), the global provider of critical data and analytics about what consumers watch and buy. Nielsen is well known for its technology and services. The company’s television ratings are the de facto currency for media and advertising decisions totaling hundreds of billions of dollars globally. Its consumer purchase data is unmatched in scope and scale, and therefore mission-critical