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 September 30, 2014, the average annual total returns of Ariel Appreciation Fund (Investor Class) for the 1-, 5- and 10-year periods were +12.22%, +16.54% and +8.80%, respectively. 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.
Quarter Ended September 30, 2014
The third quarter of 2014 experienced a sharp divergence between the major stock market indexes. While domestic large caps inched ahead, foreign stocks fell, and U.S. small caps dropped rather sharply. Specifically, the S&P 500 Index gained +1.13%, the MSCI EAFE Index returned -5.83% and the Russell 2000 Index slid -7.63%. Spreads this wide between large-cap and small-cap returns in just one quarter are rare. The last time the Russell 1000 and Russell 2000 indexes differed by more than this quarter’s 801 basis points was in the 2008 crash, and the last time Russell’s large-cap bogy outperformed the small-cap one by this much was in 1999. Whether this quarter will be a bump in the road or the beginning of some form of broad dislocation is unclear; we are being opportunistic in the search for any and all values that may arise. Ariel Appreciation Fund slid -2.97%, slightly lagging the Russell Midcap Value Index’s -2.64% decline, as well as the -1.66% return of the Russell Midcap Index.
Several of our holdings posted strong returns this quarter. Banking and wealth management firm Northern Trust Corp. (NTRS, Financial) advanced +6.45% as investors prepared their portfolios for a rising interest rate environment. Extremely low short-term interest rates have weighed heavily on Northern Trust’s business for years, but the Federal Reserve is finally showing signs it will allow rates to rise. We have always considered the low-rate environment a temporary situation and have used a long-term, normalized view when considering the bank’s intrinsic value. In addition, asset manager Janus Capital Group Inc. (JNS, Financial) leapt +17.30% in the wake of “Bond King” Bill Gross’s arrival. Gross, who founded and was lead investor for PIMCO, unexpectedly joined Janus to manage its unconstrained bond strategy. Neither we nor anyone could have anticipated this development, but we see it as a side benefit of Janus CEO Dick Weil’s long tenure at PIMCO.
A few of our holdings struggled throughout the quarter. Medical devices maker St. Jude Medical, Inc. (STJ, Financial) dropped -12.79% after delivering guidance that disappointed Wall Street. The company expects third quarter 2014 adjusted net earnings to be in the range of $0.95 to $0.97 per share— below the consensus expectation of $1.00 per share. While the market is clearly focused on the very short term, we home in on the franchise’s status as the go-to expert on implantable defibrillators and heart valves, among other products. Also, helicopter provider Bristow Group Inc. (BRS, Financial) dropped -16.28% as the market punished natural resources shares. Although Bristow has its own results and cash flows, the stock tends to trade with oil prices, which slid from $102 per barrel to $91 in the third quarter of 2014. We remain satisfied with Bristow’s fundamentals, the status of its long-range contracts and its valuation.
During the third quarter, shortly after we initiated a position in Bally Technologies, Inc. (BYI, Financial) in Ariel Appreciation Fund, the company announced that it will be acquired by Scientific Games Corp. (SGMS, Financial) in a $5.1 billion transaction, and we exited based on the update. Similarly, we also sold our shares of International Game Technology (IGT, Financial) on the good news that it was being acquired by GTECH for $6.4 billion.
At Ariel, we do not let Mr. Market’s mercurial nature and occasional gloom whipsaw our own perspective. The market has hummed along for the past few years with relatively little pain, which can lull the crowd into complacency. As independent thinkers, however, we stay focused on valuation levels and become pessimistic when bullishness is widespread rather than when others are nervous. We have been cautiously optimistic for some time. We would not go so far as to welcome negative returns, but we think a slowdown or slight pullback is healthy at this point.
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 9/30/14, Janus Capital Group Inc. constituted 1.1% of Ariel Appreciation Fund; Northern Trust Corp. 3.6%; Bristow Group Inc. 4.4%; St. Jude Medical, Inc. 2.5%; Bally Technologies, Inc. 0.0%; Scientific Games Corp. 0.0%; and International Game Technology 0.0%. 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 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index, representing approximately 92% of the total market capitalization of that index. It includes approximately 1000 of the largest 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.
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.
