How did Ariel Investments’ flagship Ariel Fund, investor class, become the top-performing mid-cap core fund since the March 9, 2009, stock market bottom, according to Lipper, during a time when value investing, which is its calling, was out of favor and the fund charged an expense ratio slightly above 1%?
A new report, “From the Front Lines of the Financial Crisis,” plus a media briefing with Ariel’s CEO, John Rogers; investment head, Charles Bobrinskoy; and research director, Timothy Fidler, provides some answers, including lessons the Chicago-based $13 billion employee-owned firm learned from the crisis.
Here are some of the highlights:
A focus on balance sheets. During the financial crisis, ratings agencies were slow to downgrade corporate debt, and banks, worried about ability of companies to service their debt, often refused to refinance debt, according to Bobrinskoy. As a result, companies had to issue equity to raise funds to service their debt, he explained.
Even Tiffany, a company Ariel owned then and now, wasn’t able to refinance debt in 2009 due to fears of massive deleveraging. Then Warren Buffett agreed to buy the company’s debt, eventually buying $250 million worth.
“Debt levels will be important in the next downturn,” Bobrinskoy said, noting that they have been rising while many A-rated credits have been downgraded to BBB. He said studying debt covenants and following the credit default swap market — “they are betting on companies every day” — can help uncover balance sheet issues.
The importance of behavioral finance. “It’s one thing to study behavioral finance… it’s another thing to try to put it to work,” said Bobrinskoy, who like Fidler received his MBA from the University of Chicago Booth School of Business where Richard Thaler, one of the founding fathers of the discipline, teaches and where former Ariel board member Tobias Moskowitz, another adherent, also taught.
Bobrinskoy said that every member of his department did a self-assessment of their own biases and which ones they thought the firm as a whole was exhibiting, and they uncovered several: the endowment effect, which overvalues stocks the firm owns relative to those it doesn’t; anchoring estimates, whereby a firm is slow to incorporate new information about a company; and loss aversion — “all human beings put more weight on losses than gains” — which leads to a reluctance to sell stocks that have lost value.