Ariel Investments monthly commentary for the month ended April 30, 2015.
H/T Dataroma
In the March monthly commentary, we discussed how our investment activity drove Ariel Fund’s strong bull market performance, examining focus, concentration and the trading of portfolio holdings. In our traditional value quarterly letter from the same period, we examined K. J. Martijn Cremers’s Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, to explore the benefits of being highly active managers with long holding periods. This month, we will bring the two topics together and dive deeper to study portfolio turnover.
As you know, we strive to be patient investors—and indeed, we hold our stocks much longer than most active managers, as noted in Cremers’s paper. One could easily make some incorrect assumptions, however, about the way long holding periods drive outperformance. For instance, one might assume that the best way to invest is to “buy and hold,” limiting the buying and selling of shares in a stock to a minimum while you own it. Or one might think if a long holding period is good, then a longer holding period is better—that one should swap stocks only begrudgingly. While Cremers’s work adds to the evidence that many professional investors buy and sell too much, we think inactivity can also degrade performance. In other words, as in many endeavors, moderation is key: Turnover can be too high or too low, with the optimal amount being somewhere in the middle.
Ariel Investments’ portfolio turnover
To illustrate the point, we will use Ariel Fund, whose performance over the past six year years proves it to be a successful example of active management over that stretch. As we noted last month, from March 9, 2009 to March 9, 2015, the fund ranked number one among 259 Mid-Blend Category peers. Below are the two key measures of portfolio turnover for each calendar year during that streak:
Asset turnover measures trading in dollars: cumulative buys or sells in dollars (whichever was lower), divided by average dollars in the portfolio for the period. It describes how much you trade stocks, regardless of which stocks you trade. Name turnover measures holding replacement: the lower number of stocks added or stocks liquidated, divided by the number of stocks at the start of the period. It examines the number of holdings changing in the portfolio, regardless of dollar amounts. As you can see, the annual asset turnover for Ariel Fund is at least double and up to nearly six times as high as the name turnover. While these percentages are not strictly comparable, they do show that there is considerable incremental buying and selling within the portfolio. Ariel Fund did not simply buy a stake in a stock and hold onto all the shares until liquidation.
Stocks we no longer own are highlighted in grey. As you can see, there are three top stocks and five bottom stocks. These numbers suggest we eliminate ideas that are not working and hold onto those that are. Indeed, a consideration in liquidating CBS Corp. (CBS) and Nordstrom, Inc. (JWN) was that the companies had become too large. In addition, we do not simply “let winners run” without trimming positions: Note that we reduced the share counts in nine of the top 10 stocks from 2009 to 2012, and reduced all the stocks we still held from 2012 to 2015. Finally, it is worth noting that all of our top-10 stocks over the period were holdings at the 2009 bottom, while none of the worst-performing stocks were in the portfolio at that time. Our long holding duration means that seven of the 10 best performers remain in the portfolio. Even after their stock prices multiplied in value, we held because we thought they represented shares in good businesses that were still good values. Our bottom performers, on the other hand, fall into two camps: mistakes we culled and stocks that have not yet had time to work. Thus far, some are up, just not as much as the portfolio, while others are down.
Ariel Investments: A successful process in active management
We would argue that the recipe for a successful process in active management is not as simple as it might seem. It does not simply mean investing with conviction and putting the portfolio on autopilot. It means removing mistakes, holding stocks that have yet to work, trimming winners that are still good values, and selling top stocks that are pricey or have become pure mid-caps. That may sound difficult, but the philosophy is actually more straightforward: One should look past stocks’ trailing performance, focus on value and hold the companies that seem to have an advantageous balance of low valuation and good growth ahead of them. The opinions expressed are current as of the date of this commentary but are subject to change. The details offered in this commentary do 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.
Past performance is no guarantee of future results. Investing in small- and mid-cap stocks is riskier and more volatile than investing in large-cap stocks. The intrinsic value of the stocks in which the funds invest may never be recognized by the broader market. Ariel 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.
This commentary lists stocks which were held and were top and bottom performers in Ariel Fund during the periods referenced. Top and bottom performers were calculated by calculating the weight invested in each stock multiplied by the rate of return for that stock during the period. These stocks do not represent all of the holdings in Ariel Fund. As of 03/31/15, Gannett Co., Inc. 3.3% of Ariel Fund; CBRE Group, Inc. 3.2%; CBS Corp. 0.0%; Royal Caribbean Cruises Ltd. 2.7%; JLL 3.1%; Interpublic Group of Cos., Inc. 2.9%; Janus Capital Group Inc. 2.2%; Newell Rubbermaid Inc. 2.7%; Nordstrom, Inc. 0.0%; Tiffany & Co. 0.0%; MTS Systems Corp. 2.3%; Zimmer Holdings, Inc. 0.0%; Herman Miller, Inc. 0.0%; Brink’s Co. 0.0%; Bristow Group Inc. 3.0%; Symmetry Medical Inc. 0.0%; Blount Intl, Inc. 2.0%; Kennametal Inc. 3.3%; DeVry Education Group Inc. 0.0%; and Contango Oil & Gas Co. 1.6%. 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 Fund. The stocks identified do not represent all of the securities purchased or sold during the period. Morningstar rankings: ©2015 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
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.
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