Ariel Fund’s commentary for the first quarter ended March 31, 2015.

H/T Dataroma

We will not beat around the bush: We are very proud of our flagship Ariel Fund’s performance record. Within its Morningstar1 Mid-Blend Category, the Fund ranks in the top decile over the trailing 1-, 3-, 5-, and 15-year periods as of March 31, 2015. True, no fund has a spotless record: Ariel Fund ranks in the 70th percentile over the 10-year period. That decade-long period contains the 2006-2008 period when the Fund struggled. But just as there are periods where a fund is out of favor, there are periods where everything clicks. In the six years between the March 9, 2009 bottom and March 9, 2015, Ariel Fund ranks number one in the 259 funds in this same category. Moreover, its performance over that stretch has been balanced. Among funds that existed in March 2009 as well as March 2015, Ariel Fund ranked number one among 259 category peers in the three years from March 9, 2009 to March 9, 2012, and it ranked number four among 322 in its category in the three years from March 9, 2012 to March 9, 2015.

True to our fiercely competitive form, we are not resting on our laurels but are investigating the period in order to keep the streak alive. We want to deeply examine our activities in the periods from 2009 to 2012, and 2012 to 2015 to determine what lessons we could draw that we can apply going forward.

Ariel Fund: Investment Philosophy

To be sure, we knew the big things had not changed: In large part our people, process and especially our philosophy have remained quite stable over the last decade. We remain value investors who strive to purchase shares in growing companies that trade at a large discount to their intrinsic values. We intend to hold them while the gap between price and value closes, which typically takes several years. With all that in mind, we decided to examine Ariel Fund’s holdings in March 2009, March 2012 and March 2015 to search for patterns that drove performance over back-to-back three-year periods.

The focus and concentration of Ariel Fund shifted meaningfully but gradually over the period. As of March 31, 2009, we held 31 equity positions in the Fund, which is toward the low end of our historical range. As the bear market ravaged stock prices and sent valuations to once-in-a-lifetime lows in early 2009, we concentrated on our best opportunities and shed other holdings. We also devoted a high percentage of our assets into the top ten holdings: 42.6%. Then, as stocks appreciated substantially over the next three years, we gradually built our roster of holdings, reaching 37 by March 2012. We also made the portfolio slightly more even by weight: In March 2012 the top 10 stocks held 36.9% of assets. This flattening continued the next three years, as the roster of stocks shrank slightly to 35, but with only 33.3% of assets in the top 10. Note that the shift was neither massive nor sudden; it was a tilt, rather than a sharp turn.

Ariel Fund: Portfolio holdings

The roster of specific holdings in the Fund was neither wholly static nor largely erratic. Rather, a fluid shift occurred over the period. Indeed, our overall portfolio turnover ratio was very similar to our long-term pattern: The annual median was 30% during the six years, within our normal range. If you assume that, typically, about half of turnover is position adjustment and the other half is swapping old holdings for fresh names, a 31-holding portfolio should retain roughly 13 of its original holdings at the end of six years. Indeed, of the 31 holdings in Ariel Fund six years ago, 14 remain in the portfolio today. Also, the addition of new holdings was balanced over the two three-year periods. Of the 21 new holdings today, 11 came between March 2009 and March 2012 and 10 more in the last three years. As you would expect, the holdings that departed did so for any number of reasons: Some were acquired, some no longer fit our original thesis, some became expensive, and some eventually exceeded our market cap range.

Finally, the record shows a flexible handling of the stocks that remained in the fund for all six years. A few were top holdings in 2009, 2012, and 2015, suggesting their valuation was attractive and our confidence high throughout the period. For instance, real estate firm JLL ranked in the top 10 holdings in all three March portfolios, while competitor CBRE Group, Inc. (CBG) ranked in the top 15 all three times. Other holdings, such as Meredith and Sothebys, were modestly sized positions as the first quarters of 2009, 2012 and 2015 ended. There was not always continuity, however. Some of the stocks we thought were screamingly cheap in 2009 remain in the portfolio and at considerably lower weights: Janus Capital Group Inc. (JNS) was a top five holding in 2009 and 2012, but now ranks 25th in the portfolio. Royal Caribbean Cruises Ltd. (RCL) was originally a top five holding as well but fell just outside the top 10 holdings in 2012 and 2015. On the flip side, some holdings from 2009 got cheaper in our eyes, so we raised their weighting over the years: Brady Corp. (BRC) was in the middle of the portfolio in 2009 and 2012 but is now a top 10 holding.

The record tells us we did not employ unusual tactics during the period of unusually good performance; rather, we simply executed our strategy well. By focusing intently on intrinsic value, we were able to maintain nearly half the portfolio, gradually shed the other half and replace stocks we sold with new positions. The rather mundane and yet encouraging lesson is that the sharp performance edge over the last six years did not come from a change to the game plan, but rather to its precise execution during a time when external changes were significant and frequent.

Ariel Fund Q1 2015 Commentary