It may seem only natural that Chicago-based Ariel Investments’ flagship $2.3 billion Ariel Fund attracts more attention than the firm’s other products. After all, it invests in small- to mid-cap companies and Ariel Investments made its reputation by investing in that space. It is also Ariel’s longest running fund and it ranks in the ninth percentile of all mutual funds in existence since its inception in November 1986.
Yet Ariel’s close-knit team of investment professionals believes their other products, notably Ariel Appreciation Fund and Ariel Focus Fund, also have much to offer advisors in building diversified portfolios for their clients. These funds invest in mid- and large-cap companies, respectively, and are managed in the same focused manner as the more high profile Ariel Fund–one that is grounded in independent thinking and analysis aimed at uncovering great companies at bargain prices whose true value will be realized over time. This investment approach embodies the core idea upon which Ariel Investments was founded in 1983, and although the firm has grown significantly since then, both in terms of personnel and AUM, it remains true to its original philosophy, applying one idea to all of its products.
“The same basic human behavioral drivers of fear and greed that create our investment opportunities affect all stocks, small and large,” says John Rogers, Ariel’s founder, chairman, CEO and CIO. “We believe strongly that our approach is universal and effective across the cap range that our performance history supports.”
A Focused Approach
That performance history is certainly impressive: As of the one year ended April 30, 2010, the $1.6 billion Ariel Appreciation Fund (CAAPX) returned 66.64%, beating the Russell Midcap Value Index’s return of 54.39%. The $60 million Ariel Focus Fund returned 42.64% for the same time period, compared to a return of 42.28% for the Russell 1000 Value Index.
All three funds have also managed to remain leaders in their market segments and to stay the course through various economic cycles. Ariel Fund is nearly a quarter of a century old, while the Ariel Appreciation Fund has been around for over 20 years. The Ariel Focus Fund (ARFFX) celebrated its fifth anniversary on June 30, 2010.
“It’s rare to have that kind of longevity and continuity and to be able to go through all kinds of cycles,” Rogers says.
Through its 27-year history, Ariel Investments has been able to develop a real “circle of competence,” says Timothy Fidler, senior VP at Ariel and member of the firm’s investment committee. “We’ve been able to really get to know companies in terms of the businesses we are looking for, and we have been able to bring our industry expertise to suit that.”
Both Rogers and Fidler attribute the bulk of the Ariel Funds’ success to their consistently focused nature, which is the same in the small-, mid-, and large-cap spaces.
“We try typically to own 40 or fewer stocks and we concentrate on stocks we know and understand because we feel this leads to better performance,” Rogers says.
But the stocks the team picks are usually not mass-market favorites. In fact, they are often quite the opposite.
“We like to buy wonderful ideas and great businesses–but when they are out of favor,” Rogers says. “It may be uncomfortable to do this, but we try and think individually and not let group thinking drive us.”
Gold Among the Market Dross
It is not always easy to go against the grain, particularly when markets are in tumult. But the Ariel team has always stuck to this approach, even in 2009, during the very worst of the market downturn. At that time, the cheapest stocks were the ones in such downtrodden sectors as media, real estate, and retail, areas that were the most reviled by the market at large, Fidler says. Naturally, people feared the worst for companies in those sectors and stayed far away from them, but Ariel still believed that there were a few businesses in those sectors with tremendous franchises and great future potential that were being unfairly penalized by broader financial market and macroeconomic dynamics, and so the firm’s mission in the first quarter of 2009 was to find those companies. The investment management team scoured balance sheets to descry those players that would survive the downturn and then go on to prosper in an economic rebound, and in so doing, they hit upon names like real estate company C.B. Richard Ellis; global auction house Sotheby’s; and luxury retailer Nordstrom. In the media sector, the value discoveries included Gannett and CBS.
These and other names chosen at the time, Fidler says, contributed to the funds’ outsized performance in 2009 and into 2010. Indeed, just over a year following the market bottom on March 9, 2009–when it seemed the markets would never recover–Ariel Appreciation Fund returned an impressive 125.75%. The Ariel Focus Fund, for its part, posted 82.05% as of April 30, 2010.
“When the market turned, people realized that these companies we’d invested in were severely underpriced,” Fidler says. “Some of those names are still great businesses that we want to hold onto because we still think they are cheap from a valuation point of view and we think the earning power is still there, so we are keeping them.”
Companies like Sotheby’s are exactly the kinds of investments that Ariel is looking for. Sotheby’s had been reaping the benefits of a very strong global art market, Fidler says, but in late 2008, when recession started to settle in and the art market took a big hit, Sotheby’s started to suffer.
“The company has been around for hundreds of years, though, and it’s a unique company with a balance sheet that has enough [of a] margin of safety,” Fidler says. “People tend to dump those kinds of stocks, but if you fast forward to today, you can clearly see a shift in sentiment; bottom line, it comes down to being able to know and then own the underlying business.”
The Stock-Picking Process
This is Ariel’s modus operandi even in ‘normal’ market conditions. The investment team spends a great deal of time getting to know companies deeply. Unlike other fund companies where junior analysts do a lot of the legwork, each investment professional at Ariel–there are 10–is in charge of two industry areas, and spends a great deal of time sourcing out companies in their mandated sectors. In addition to analyzing those companies with a suite of quantitative tools, the investment professionals spend a lot of time on conference calls and make it a point to get on the road to meet in person with management teams.
“We also look beyond managers’ resumes to touch upon an independent network of contacts in order to try and source information from original proprietary sources,” Fidler says. “Every one of us has a terrific Rolodex of contacts because [qualitative analysis] is a big part of what we do.”
The bottom line for Ariel and what the firm’s due diligence process leads to is the confidence to invest in companies that the firm can hold for a long time in each of its portfolios. Patience, i.e., waiting out the time it takes for a particular company to realize its potential, is the team’s greatest virtue and chief strength, and being patient means looking at a particular company not only in terms of its stock and where that stock may be trading, but rather, through a kind of Warren Buffett lens that evaluates it as a business with (or without) long-term potential.
Big brands like food products company McCormick, or global names like management consultancy firm Accenture, both of which continue to grow and generate a lot of cash, fit Ariel’s bill, as does a company like outsourcing leader Hewitt Associates, whose stock the investment team bought three years ago when it deemed Hewitt was greatly undervalued. Hewitt still has gains to realize because the outsourcing theme is still unfolding, says Matthew Sauer, senior VP and member of the investment committee, “so we are still holding onto it.”
Where Does Value Exist Now?
Recently, Ariel has been looking more closely at the healthcare sector. The firm hasn’t really owned much in the area over the years, Fidler says, as the healthcare business model hasn’t suited Ariel’s investment goals, but since the raging debate over healthcare reform and the passage of healthcare reform legislation, the investment team has been finding some good value in certain healthcare names like Baxter, a global medical products and services company, and Zimmer, a leading manufacturer of orthopedic products.
“We added these names over the past nine months and they will have value over time as people digest healthcare reform,” Fidler says.
While it’s harder to find value in deeper cyclical sectors like energy and utilities, the Ariel team has also uncovered some opportunities in the consumer and financial sectors, particularly on the small-cap side, where there are a number of companies with attractive valuations and, again, the ability to grow over time.
Ariel Investments’ team has worked together for a number of years now. Rogers–whose father gave him stock for birthdays and Christmases and whose passion for investing began at the age of 12–serves as lead portfolio manager for the Ariel Fund and the Ariel Appreciation Fund, and he is also the lead portfolio manager for company’s small/mid- and mid-cap value products. Fidler serves as co-portfolio manager of the Ariel Focus Fund and Ariel Focused Value, and he is also a portfolio manager for the Ariel Appreciation Fund and Ariel Mid Cap Value, working closely with lead portfolio manager John W. Rogers, Jr. and portfolio manager Sauer. Fidler also oversees the firm’s proprietary research in the retail and business services industries.
Savita Iyer-Ahrestani is a freelance business journalist currently based in New Jersey. She can be reached at [email protected].