Value Investing

Ariel Appreciation Fund 4Q15 Commentary

Ariel Appreciation Fund commentary for the fourth quarter ended December 31, 2015.

H/T Dataroma

The fourth quarter of 2015 was a positive end to a mixed year for equities. The three flagship indexes tracking our asset classes all rose nicely. Specifically, the large-cap S&P 500 Index rose +7.04%, the small-cap Russell 2000 Index gained +3.59%, and the large-cap, developed-market MSCI EAFE Index advanced +4.71%. These quarterly results continued an intriguing pattern for the year: domestic small caps and international large caps tracked each other more closely than either one of them paralleled domestic large caps. A large/small split or a domestic/foreign divide would make sense, but the pattern from 2015 is a bit confusing from an economic, fundamental basis. That said, in equities returns can stem from sentiment or understandings of risk and growth rather than fundamentals: the theme of “risk on” versus “risk off” sometimes tells the story. From that angle, the performance pattern does follow. It seems investors were moderately optimistic in the first half of the year, fairly fearful in the third quarter, but hopeful in the final three months.

Ariel Appreciation Fund

Ariel Appreciation Fund – Performance

This quarter, Ariel Appreciation Fund jumped +4.78%, ahead of the Russell Midcap Value Index’s +3.12% rise, as well as the +3.62% return of the Russell Midcap Index.

Ariel Appreciation Fund – Portfolio Holdings

Some of our holdings posted solid gains for the quarter. Advertising concern Interpublic Group of Cos., Inc. (IPG) advanced +22.32% after a strong quarterly earnings report. Based on revenues and margin that were better than the prior year, the company earned $0.27 per share—ahead of the $0.25 per share expectation. We still think advertising is expanding in ways that drive Interpublic Group’s success, while the crowed is pessimistic about ads in general and established advertising firms in specific. Toy-maker Mattel, Inc. (MAT) returned +31.09% after naysayers started turning positive. For some time this company and the whole industry have been in the doghouse. But consultants and analysts have become more positive on the toy business and, at Mattel, on key brands Barbie and Fisher Price. As often happens with broad predictions of immense change, we think the notion that children will suddenly stop playing with Barbie dolls and switch wholesale to digital entertainment goes way too far.

Other holdings fell amidst the volatility the past three months. Cutting tool and tooling systems maker Kennametal Inc. (KMT) returned -22.33% as end demand has been weaker than previously expected. That cyclical issue has crimped cash flows, making it rather challenging for new CEO Don Nolan to fully execute his plan to improve efficiency via modernization. Long term we think the future is fairly clear; it simply will take longer than we (and the company) previously expected. Upscale department store Nordstrom, Inc. (JWN) declined -25.11% after missing earnings. Broad-based weakness, largely driven by slow traffic, caused the company to earn $0.57 per share during the quarter—well short of the expected $0.72. Nordstrom slashed prices to clear inventory, which was painful short term but now puts it in shape to succeed from this point forward.

In the last quarter of the year, we acquired one new security and exited one in Ariel Appreciation Fund. We gained a new position in integrated sports, entertainment and media business company The Madison Square Garden Co (MSG) as it completed its spin-off from MSG Networks Inc (MSGN), the company that was formerly known as Madison Square Garden Co. We already held shares of the former Madison Square Garden, whose main business focuses on media as a regional sports network. The new Madison Square Garden’s business focuses on sports and entertainment with various sports teams and theaters as some of the brands under its belt. We sold our position in Sotheby’s (BID) to pursue more compelling mid-cap opportunities.

Although it may not bring immediate emotional (or financial) rewards, a flat or softly down year in a long, rising market can be a good thing. So long as there is economic growth, as there was in 2015—such a pause means stocks are cheaper at year-end than they were at the beginning. So, we enter 2016 with the same basic view we held entering 2015 as well as 2014. That is, we are confident and optimistic about U.S. fundamental growth and slightly cautious about the valuation of domestic stocks. Overseas, we think there is a more fundamental risk—especially in China—but we see international stocks broadly as less expensive. Taken altogether, that means we see a “stock-picker’s market” where choosing individual securities within a set of stocks has greater potential to  contribute more strongly to returns than the choice of one set of stocks over another. Of course we always embrace the philosophy of  long-term investing and strongly prefer it to any attempt to time the market or seek out turning points, bottoms, tops, and so forth.