Ariel Appreciation Fund’s commentary for the fourth quarter 2014.
H/T Dararoma
Investing in mid-cap stocks is riskier and more volatile than investing in large-cap stocks. The intrinsic value of the stocks in which the portfolio invests may never be recognized by the broader market. Ariel Appreciation Fund often invests a significant portion of its assets in companies within the financial services and consumer discretionary sectors and its performance may suffer if these sectors underperform the overall stock market.
Performance data quoted represents past performance. Past performance does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains, and represents returns of the Investor Class shares. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For the period ended December 31, 2014, the average annual total returns of Ariel Appreciation Fund (Investor Class) for the 1-, 5- and 10-year periods were +8.15%, +15.90% and +8.56%, respectively. The Fund’s Investor Class shares had an annual expense ratio of 1.12% for the year ended September 30, 2014. The Fund’s Investor Class shares had an annual expense ratio of 1.13% for the year ended September 30, 2013. Performance data current to the most recent month-end for Ariel Appreciation Fund may be obtained by visiting our website, arielinvestments.com.
Ariel Appreciation Fund: 4Q commentary
In the fourth quarter of 2014, the U.S. stock market continued one recent pattern and broke another. The large-cap S&P 500 Index gained +4.93% and the small-cap Russell 2000 Index gained +9.73%. On an absolute level, it was a very strong quarter, which continues the pattern for fourth quarters since 2009: With only one exception in 2012, both indices have posted gains in the final three months of the year. In 2010, 2011 and 2013, at least one of the two had double-digit percentage returns, and the Russell 2000 was obviously tantalizingly close this year. On the other hand, it reversed the market-cap trend for 2014. In the first nine months of the year, the larger the market-cap range, the better the performance: Large beat mid, which beat smid, which topped small, which outdid micro. That order was essentially reversed in the fourth quarter.
The story was different overseas for the quarter and year. Specifically, international stocks retreated modestly over the recent 3- and 12-month periods. The MSCI EAFE Index gave up -3.53% in the quarter and -4.48% in 2014. Fears of a European downturn, recession in Japan and a global shock starting in China were the main culprits.
This quarter, Ariel Appreciation Fund jumped +7.38%, ahead of the Russell Midcap Value Index’s +6.05% rise, as well as the +5.94% return of the Russell Midcap Index.
Ariel Appreciation Fund: Portfolio holdings
Some of our holdings rose significantly for the quarter. Mortgage insurer First American Financial Corp. (FAF) surged +25.91% as its business gained momentum. Its earnings per share for the quarter were in line with expectations (excluding investment gains and taxes), while claims were lower than expected. More importantly, residential purchases strengthened recently, and the commercial outlook is quite good. The company has had good earnings the past few years while swimming upstream, so it should do even better if a moderately favorable environment emerges. In addition, money transfer leader Western Union Co. (WU) jumped +12.48% due to a good earnings report and a promising outlook. Its revenue was up 2% this quarter and grew in every region, plus its profitability improved. The company raised its guidance for the full year to $1.50 per share, which was at the top of its previously stated range and higher than the Street’s $1.47 estimate. That, coupled with the ongoing and significant stock repurchase plan, signals a management team that is confident, despite the crowd’s previously modest expectations.
Other holdings slid in the short term. Natural gas company Contango Oil & Gas Co. (MCF) dropped -12.03% due to an earnings report that disappointed the Street. Specifically, Contango reported earnings per share of $0.19, well below the consensus estimate of $0.26. Its production was at the low end of its forecasted range, and a temporary lowering of production in one of its fields was the most significant driver of the overall result. The issue was temporary, the company’s recent exploration woes are in the past, and we think the company is rediscovering its footing. We continue to own the stock, and indeed it remains a substantial holding in our deep value portfolios. Also, tool and coating maker Kennametal Inc. (KMT) fell -12.97% due to short-term weakness in orders. At the end of October and November, the company reported declines of -1% and -3% in orders, respectively. While industrial orders have been up, infrastructure orders have been light. Kennametal is one of only three significant players in a critical niche field, and while there may be fundamental volatility short-term, the long-term demand trend for its products looks very promising.
Ariel Appreciation Fund purchases National Oilwell Varco
During the quarter, we purchased oil and gas equipment manufacturer National Oilwell Varco (NOV), but did not exit any positions in Ariel Appreciation Fund. National Oilwell Varco, a current holding in Ariel Focus Fund, has a dominant position within the offshore rig construction market (particularly in deep water) and is a top supplier of equipment for shallow-water and onshore rigs. The company also serves as a distributor of oilfield supplies through a large network of service centers across the globe. Weakness in the last quarter of 2014 afforded us the opportunity to add this company to our mid cap portfolio, since it fell within our product’s market capitalization range.
At Ariel we change our outlook due to fundamentals, not by turning calendar pages. So our outlooks from one January to the next have not differed a great deal lately. In our view, the fundamentals have remained fairly stable, and the same is true at the beginning of 2015. Regarding the U.S. economy and market, we remain confident and optimistic about U.S. growth and are only mildly cautious about valuation; this view is similar to the one we held as 2014 began. We are coming off a year of standard stock market performance, economic growth remains fairly slow and gradual, and a fair mix of optimism and pessimism pervades the investing crowd. Abroad, we think a bit more economic risk remains, but it is somewhat balanced by valuation. The big fears regarding Europe and China are indeed concerning to us: A recession for the European Union does seem likely, and the world’s most populous nation clearly has economic issues to settle. That said, foreign stocks retreated a bit this year, and valuations look lower around the globe than they are in the United States.
This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
As of 12/31/14, First American Financial Corp. constituted 5.0% of Ariel Appreciation Fund; Western Union Co. 4.7%; Kennametal Inc. 3.1%; Contango Oil & Gas Co. 0.8%; and National Oilwell Varco 1.2%. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Appreciation Fund.
The Russell Midcap® Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. It includes those Russell Midcap® Index companies with lower price/book ratios and lower forecasted growth values. The Russell Midcap® Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap® Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities on the basis of a combination of their market cap and current index membership. The Russell Midcap® Index represents approximately 27% of the total market capitalization of the Russell 1000 companies. The Russell 2000® Index is a subset of the Russell 3000® Index, representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities on the basis of a combination of their market cap and current index membership. Russell® is a trademark of Russell Investment Group, which is the source and owner of the Russell Indexes’ trademarks, service marks and copyrights. The S&P 500® Index is the most widely accepted barometer of the market. It includes 500 blue chip, large-cap stocks, which together represent about 75% of the total U.S. equities market. The MSCI EAFE® Index is an unmanaged, market-weighted index of companies in developed markets, excluding the U.S. and Canada. The MSCI EAFE Index (gross) returns reflect the reinvestment of income and other earnings, including the maximum possible dividends. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. (Source: MSCI.)
Investors should consider carefully the investment objectives, risks, and charges and expenses before investing. For a current prospectus or summary prospectus which contains this and other information about the funds offered by Ariel Investment Trust, call us at 800-292-7435 or visit our website, arielinvestments.com. Please read the prospectus or summary prospectus carefully before investing. Distributed by Ariel Distributors LLC, a wholly owned subsidiary of Ariel Investments LLC.
