Ariel Focus Fund Q3 2016 Commentary – ValueWalk Premium

Ariel Focus Fund Q3 2016 Commentary

Ariel Focus Fund commentary for the third quarter ended September 30, 2016.

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Equity markets shook off the malaise that took hold at the end of the second quarter-remember Brexit?-to post a strong quarter all around. Returns were especially good in domestic small caps and international stocks. While the S&P 500 Index advanced +3.85%; the Russell 2000 Index jumped +9.05%; and the MSCI EAFE Index rose +6.43%. The third quarter was the best period for the MSCI EAFE Index in nearly three years, and the best for the Russell 2000 Index in almost two years. We do not believe much changed to drive this result: we simply think people recognized the economy is sound and interest rates remain low—a good environment for equities. This quarter, Ariel Focus Fund rose +6.77%, ahead of the Russell 1000 Value Index’s +3.48% return as well as the +3.85% rise of the S&P 500 Index.

Ariel Focus Fund

Ariel Focus Fund


Some of our holdings rose nicely during the quarter. Investment bank Morgan Stanley (MS) advanced +24.25% on solid trading activity. The United Kingdom’s decision to exit the European Union was widely rebuked, but Brexit helped investment banks in the short term. Trading was heavy after the surprise—especially for Morgan Stanley, whose fixed income and commodities trading revenue were much higher than they have been the past few quarters. We think this shows a well-structured and diversified firm can take advantage of the unexpected. Also, private equity firm KKR & Co. L.P. (KKR) returned +16.86% due to a good quarterly earnings report. It gained nearly $9 billion in inflows, ahead of expectations. New assets, along with good returns on existing assets, brought the company’s assets under management up to $131 billion, much higher than they were a year ago. We do not think this profit engine is downshifting anytime soon.

Other holdings fell back a bit. Gold miner Barrick Gold Corp. (ABX) lost -16.91% after missing earnings expectations. Wall Street had expected the company to earn $0.15, but Barrick came in a penny short. The company continues to cut costs and slash debt, plus management kept production guidance stable. Those moves keep us fairly confident, despite the market punishment of the stock for the miss. In addition, oil and gas multinational Exxon Mobil Corp. (XOM) drifted down -6.08%. Earnings of $1.7 billion fell significantly from a year ago, when they were at $4.2 billion. As you know, oil prices have fallen sharply during the past few years, so much of the short-term shortfall is beyond Exxon’s control. We are pleased the company has remained cash flow positive, during a time when its main competitors have not.

In the third quarter, we added luxury jeweler and specialty retailer Tiffany & Co. (TIF) to Ariel Focus Fund. Tiffany exhibits several attributes we look for in an outstanding retail business: strong brand, exclusive and/or differentiated merchandise, attractive profitability, clearly defined positioning in consumers’ minds, clean balance sheet, conservative management, growth prospects, pricing power, and a demonstrated track record of prudent capital allocation. Short-term concerns regarding luxury consumption in foreign markets have provided us with an opportunity to reinitiate a position in the stock. We eliminated our position in Pier 1 Imports, Inc. (PIR) during the quarter in order to pursue more compelling opportunities.

Looking ahead, we are optimistic. That is, most of our companies have been doing well. Management teams are making rational decisions, revenues and profits look good, and the holdings in need of changes are making them. Plus we think fundamentals, broadly, are sound. True, concerns about valuation are growing, and we agree some areas of the market have questionable valuations. So we have steered clear of those areas as well as specific stocks priced for perfection. In short, we believe our own portfolios are in good shape.

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