Ariel Fund monthly commentary for the period ended February 2015.
A year ago, we analyzed performance since the market bottom in March 2009. We often repeat topics but did not anticipate a sequel to that commentary. And yet we are indeed providing an update because the story remains compelling and thought-provoking.
We will summarize last year’s perspective briefly. In the first two months of 2009, pessimism was ubiquitous and powerful. While almost everyone was talking about the preceding decade as “lost” for stocks, we were saying extraordinarily cheap stocks were likely paving the way for a great decade to come. Last year represented the 5-year anniversary of the market bottom marking the end of the financial crisis—an obvious halfway point. For that reason, we weighed in on the market’s progress; the news was very good. Interestingly, it has only gotten better since then.
Below are the results for broad indexes we posted last year alongside the new, updated figures.
Ariel Fund’s cumulative returns
For every index above, last year’s 5-year annualized return (2009-2014) is higher than this year’s 6-year return (2009-2015). On the other hand, the 6-year cumulative return in each case is higher than the 5-year cumulative return. You may wonder: Which return is more important, annualized or cumulative? We think the metaphor of speed and distance answers the question. Think of it this way: Which is better, having gone 181 miles at 23 miles per hour, or making it 225 miles at just less than 22 miles per hour? For a traveler, the farther you go, the closer you are to your goal; your average speed is less important. For an investor, the more money you make, the closer you are to your goal; the average rate of return is less important.
We should note these returns are quite unusual—roughly double the normal rate. Indeed, last year, we ran rolling 5-year returns going back to 1926 to determine that the February 28, 2009 to February 28, 2014 return ranked in the top 6% of all those periods. This year, we ran rolling 6-year returns, and with another year of solid gains, the current era looks even better. That is, for the 6-year period ended February 28, 2015, large-cap returns ranked 46th out of 999 periods, putting it in the top 5% of all those time periods.
Given the extremely low valuations of stocks in early 2009, active managers had an opportunity to add value over the next six years with savvy purchases and brave but rational conviction. Few managed the feat, as evidenced by results in Morningstar’s Mid-Cap Blend category, home to Ariel Fund, our flagship mutual fund. Indeed, of the 260 in the group dating back to early 2009, just 25 funds beat the Russell Midcap Index’s +25.29% annualized return. In other words, 90% of the funds in the category lagged one well-known, appropriate benchmark.
Ariel Fund’s performance attribution
Of the handful of funds that outperformed the market, some did so by a large amount. We are pleased to note Ariel Fund was very much in that fortunate company. We think the results come from two key sources. First, we have a very strong belief in the power of American business, a conviction that held firm in early 2009 and has not wavered since. Second, we invest heavily in those stocks that garner our confidence; we are willing to look very different from indexes and peers in our quest to beat their returns. That recipe has put Ariel Fund at the very top of the Morningstar Mid-Cap Blend category over the last six years through February 28, 2015. We find the cumulative return over the period quite easy to remember: +400%. We think Ariel Fund’s performance over the traditional 1-, 5-, and 10-year periods—for the period ending December 31, 2014—is also impressive.
Make no mistake—the results above did not come without risk. Investing in the stock market always carries risk alongside any reward, and equities are volatile. Moreover, we invest in small- and mid-cap stocks, which carry more risk and volatility than large-caps, and our focused portfolio means a lower level of diversification than a broad index. Ariel Fund also concentrates a significant portion of assets in the financial services and consumer discretionary sectors; it may well lag the market if these areas underperform. Finally, we attempt to measure a stock’s intrinsic value, which the stock market may disregard.
That said, we think the last six years also show that the intrinsic risks involved in owning a focused, actively managed, small- to mid-cap portfolio do offer the possibility of significant outperformance. We think our deep experience in the market and our philosophy of concentrating on a circle of competence are what counted when the market shifted from nearly irrational pessimism back to a more balanced, reasonable outlook in early 2009.