John Rogers’ Ariel Investments Q4 2013 Commentary
Investing in small and mid-cap stocks is more risky and more volatile than investing in large cap stocks. 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. 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. For the period ended December 31, 2013, the average annual total returns of Ariel Fund (Investor Class) for the one-, five- and ten-year periods were +44.68%, +26.01% and +8.18%, respectively. Ariel Fund’s Investor Class shares had an annual expense ratio of 1.03% for the year ended September 30, 2013 and 1.06% for the year ended September 30, 2012. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our web site, arielinvestments.com.
Both domestic and international stocks had strong returns in 2013, including the final quarter of the year. Somewhat predictably, the investment areas that were the most popular over the last half decade— bonds and emerging market stocks—had their comeuppance with negative returns for the year. And although investors were generally skeptical of developed market equities, here and overseas, most broad indices were up between +20% and +35%— well above the low double-digit historical averages. As independent thinkers, we entered the year bullish, viewing the global recovery from the financial crisis as ongoing and believing the pessimism overdone. We had good returns this quarter as Ariel Fund gained +12.99%, beating the Russell 2500 Value Index’s +8.83% jump, as well as the +9.30% rise of the Russell 2000 Value Index.
Several of our holdings posted strong returns this quarter. Asset manager Janus Capital Group Inc. (JNS) soared +46.37% on better-than-expected earnings and revenue. Specifically, in October the company reported quarterly earnings of $0.18 per share versus consensus of $0.17. Its assets under management (AUM) rose to $166.7 billion, from $158.2 billion a year ago. The company’s cash investments totaled $793 million versus $543 million in debt, giving it a positive $250 million net cash position. Finally, Janus repurchased more than one million shares of its own stock. Clearly, the roaring 2013 stock market had a good deal to do with the positive news that caught Wall Street’s attention. For our part, we were more interested in the capital allocation decisions because those are under management’s control. In addition, restructuring specialist and asset manager Lazard Ltd (LAZ) surged +27.36%, topping estimates for earnings and revenue by a significant margin. Its earnings per share for the third quarter were $0.46 versus the estimate of $0.37. The company’s operating revenue was $489 million, well above the $452 million expectation. Its September 30 AUM reached $176 billion, an all-time high to that date. We closely watch that figure, because we think it is an overlooked part of the business. Meanwhile, the global leading restructuring business had $42 million in revenue, 23% higher than a year ago. Still, restructurings continue to be well below the usual rate, leading us to believe the future is even brighter.
A few of our holdings struggled in the third quarter. Gaming equipment specialist International Game Technology (IGT) slipped –3.46% due to a disappointing earnings report. Although revenues exceeded expectations by a solid margin, EPS of $0.30 fell short of the consensus $0.34 figure. The environment was more competitive than expected, leading to fewer of IGT’s games on the floor, as well as a corresponding decline in overall play. Still, the company is allocating capital smartly. It announced a $200 million share repurchase plan, which would retire roughly 4% of the shares outstanding. We continue to think that although gaming has been softer than expected in the ongoing recovery, eventually it will pick up. Also, transaction specialist Western Union Co. (WU) returned –6.85% due to disappointing guidance. Its quarterly earnings report was solid, with earnings and revenues both above consensus. At the same time, however, the company signaled that costs for regulatory and compliance investments would be higher than expected. As a result, management expects operating profit to be flat next year, and share buybacks will be minimal. Management had been returning capital to shareowners at a steady clip: Through the first three quarters of 2013, the company returned nearly $550 million to shareholders through dividends and buybacks. Admittedly Western Union has had a difficult couple of years, but we think its economic moati is firmly in place, even though most analysts seem to be looking right past it.
In the last quarter of the year, we did not initiate or eliminate any stocks in Ariel Fund.
As we enter 2014, we are more cautious than a year ago, yet confident and optimistic. That is, sentiment has changed completely—the anxiety lingering due to equity losses during the financial crisis has morphed into enthusiasm for stocks, given their very strong returns since early 2009. We are independent thinkers rather than knee-jerk contrarians, however, so this shift does not automatically cause us to batten down the hatches. Our point of view remains: The slow, muted economic recovery is real and ongoing.
To date it has not transformed into the strong growth that typically follows a recession, but we think it will eventually get there. Perhaps—we are not macroeconomic prognosticators—that will occur in 2014. In the meantime, we continue to be highly active stock-pickers in all our strategies. The companies we choose to own appear to us to have bright futures, especially long-term but in the near- term as well.
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 12/31/13, Janus Capital Group Inc. comprised 3.6% of Ariel Fund; Lazard Ltd 3.9%; International Game Technology 3.0% and Western Union Co. 3.1%. 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.
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. The Russell 2000® Value Index measures the performance of the small- cap value segment of the U.S. equity universe. It includes those Russell 2000 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.
Investors should consider carefully the