John Rogers’ Ariel Investments commentary for the month ended July 31, 2015.
Recently, we were pleased to read a Morningstar FundInvestor article entitled, “Risk Off,” written by Director of Fund Research and Editor Russel Kinnel. The piece discusses funds with betas and standard deviations that have fallen the last few years. Kinnel dedicates a paragraph each to six mutual funds with volatility that improved dramatically over the past three years, including our flagship Ariel Fund. He describes Ariel Fund as long having “the profile of being a bit to the cautious side, with fairly stable but low P/E stocks,” and we agree. He then notes that volatility spiked in the Great Recession of 2008-2009 and summarizes the aftermath in positive terms:
The latest Robinhood Investors Conference is in the books, and some hedge funds made an appearance at the conference. In a panel on hedge funds moderated by Maverick Capital's Lee Ainslie, Ricky Sandler of Eminence Capital, Gaurav Kapadia of XN and Glen Kacher of Light Street discussed their own hedge funds and various aspects of Read More
Manager John Rogers dialed up the firm’s work on balance sheets in an attempt to manage that risk better. The fund’s performance has recovered, but even with this decline in volatility, standard deviation remains on the high side.
We took this opportunity to examine Ariel Fund’s standard deviation history, which we discuss below.
John Rogers – Ariel Fund returns measurement over the short-term vs long-term
As you know, standard deviation is the classic measurement of volatility. Specifically, it measures how much a fund’s returns differ over the short-term versus its own long-term average. We ran three-year rolling standard deviation figures from January 1, 1987 (shortly after Ariel Fund’s inception) through June 30, 2015. Up until the end of 2007, as Kinnel suggests, Ariel Fund’s median standard deviation was slightly below its category peers and indexes: Ariel Fund, +14.00; Russell 2500 Value Index, +15.20; and the Morningstar Mid-Cap Blend category, +14.42. And yet, it has been more volatile since early 2009.
To the latter point, the FundInvestor article specifically examines the period from mid-2012 to mid-2015, where an interesting wrinkle appears. Kinnel correctly notes that Ariel Fund’s standard deviation drops from 26 to 13 but remains above the mid-blend peer average of 10. In light of its own long-term history, however, Ariel Fund’s drop was from very far above normal to well below normal. Three years ago, Ariel Fund’s standard deviation of 26 was well above its long-term average of 16, and now at 13, it is well below its long-term average. It remains higher than its benchmark and peers only because both the Russell 2500 Value Index and the Mid-Blend category average have fallen to even lower historical levels than their own historical norms. Their current standard deviations are about 66% of their multi-decade averages. To summarize: We all know that volatility was especially high during and after the Great Recession, but few seem to recognize that volatility in U.S. stocks is now remarkably low.
With that, we turn to the truism that Ariel’s global portfolio manager Rupal J. Bhansali noted at a recent conference in Sydney, Australia: “Stability is not always your friend, and volatility is not always your enemy.” Bhansali points out that risk and return are always linked, and in many cases, there is a trade-off between them. It makes sense then to consider risk in light of returns rather than independently. Since the Great Recession, many assets that demonstrate relative or absolute stability have seen valuations rise. And, in our view, somewhat more volatile securities have been cheap relative to intrinsic value and history. Also, over the last three years, Ariel Fund’s volatility has indeed been above that of our peers and benchmarks, but its returns have also been higher. From 6/30/12 – 6/30/15, the Fund has gained +22.94% annually, well above the Russell 2500 Value Index’s +16.99% rise and the Morningstar Mid-Blend category average’s 17.41% return.
In the big picture, as we see it, Ariel Fund’s standard deviation jumped to abnormally high levels in the crisis and has fallen to an abnormally low level at this point. That fall in volatility also accompanied returns that were well above historical averages and relevant benchmarks. We think shareholders have thus had an attractive experience the past three years: above-average returns with belowaverage volatility.