A year ago, we analyzed performance since the market bottom in March 2009. We often repeat topics but did not anticipate a sequel to that commentary. And yet we are indeed providing an update because the story remains compelling and thought provoking.
We will summarize last year’s perspective briefly. In the first two months of 2009, pessimism was ubiquitous and powerful. While almost everyone was talking about the preceding decade as “lost” for stocks, we were saying extraordinarily cheap stocks were likely paving the way for a great decade to come. Last year represented the 5-year anniversary of the market bottom marking the end of the financial crisis—an obvious halfway point. For that reason, we weighed in on the market’s progress; the news was very good. Interestingly, it has only gotten better since then.
Below are the results for broad indexes we posted last year alongside the new, updated figures.
For every index above, last year’s 5-year annualized return (2009-2014) is higher than this year’s 6-year return (2009-2015). On the other hand, the 6-year cumulative return in each case is higher than the 5-year cumulative return. You may wonder: Which return is more important, annualized or cumulative? We think the metaphor of speed and distance answers the question. Think of it this way: Which is better, having gone 181 miles at 23 miles per hour, or making it 225 miles at just less than 22 miles per hour? For a traveler, the farther you go, the closer you are to your goal; your average speed is less important. For an investor, the more money you make, the closer you are to your goal; the average rate of return is less important.
We should note these returns are quite unusual—roughly double the normal rate. Indeed, last year, we ran rolling 5-year returns going back to 1926 to determine that the February 28, 2009 to February 28, 2014 return ranked in the top 6% of all those periods. This year, we ran rolling 6-year returns, and with another year of solid gains, the current era looks even better. That is, for the 6- year period ended February 28, 2015, large-cap returns ranked 46th out of 999 periods, putting it in the top 5% of all those time periods.
Given the extremely low valuations of stocks in early 2009, active managers had an opportunity to add value over the next six years with savvy purchases and brave but rational conviction. Few managed the feat, as evidenced by results in Morningstar’s Mid-Cap Blend category, home to Ariel Fund, our flagship mutual fund. Indeed, of the 260 in the group dating back to early 2009, just 25 funds beat the Russell Midcap Index’s +25.29% annualized return. In other words, 90% of the funds in the category lagged one well-known, appropriate benchmark.
Of the handful of funds that outperformed the market, some did so by a large amount. We are pleased to note Ariel Fund was very much in that fortunate company. We think the results come from two key sources. First, we have a very strong belief in the power of American business, a conviction that held firm in early 2009 and has not wavered since. Second, we invest heavily in those stocks that garner our confidence; we are willing to look very different from indexes and peers in our quest to beat their returns. That recipe has put Ariel Fund at the very top of the Morningstar Mid-Cap Blend category over the last six years through February 28, 2015. We find the cumulative return over the period quite easy to remember: +400%. We think Ariel Fund’s performance over the traditional 1-, 5-, and 10-year periods—for the period ending December 31, 2014—is also impressive.
Make no mistake—the results above did not come without risk. Investing in the stock market always carries risk alongside any reward, and equities are volatile. Moreover, we invest in small- and mid-cap stocks, which carry more risk and volatility than largecaps, and our focused portfolio means a lower level of diversification than a broad index. Ariel Fund also concentrates a significant portion of assets in the financial services and consumer discretionary sectors; it may well lag the market if these areas underperform. Finally, we attempt to measure a stock’s intrinsic value, which the stock market may disregard.
That said, we think the last six years also show that the intrinsic risks involved in owning a focused, actively managed, small- to mid-cap portfolio do offer the possibility of significant outperformance. We think our deep experience in the market and our philosophy of concentrating on a circle of competence are what counted when the market shifted from nearly irrational pessimism back to a more balanced, reasonable outlook in early 2009.
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 equity stocks is risky and subject to the volatility of the markets. Investing in small-cap and mid-cap stocks is more risky and more volatile than investing in large-cap stocks. The intrinsic value of the stocks in which the Fund invests may never be recognized by the broader market. An actively managed portfolio is more risky than a passively managed portfolio that replicates an index because it contains fewer stocks than its benchmark. The Funds concentrate a significant portion of their assets in the financial services and consumer discretionary sectors, and performance may suffer if these sectors underperform the overall stock market. Ariel Fund’s Investor Class shares had an annual expense ratio of 1.03% for the year ended September 30, 2014. Bonds are fixed income securities in that at the time of the purchase of a bond, the amount of income and the timing of the payments are known. Risks of bonds include credit risk and interest rate risk, both of which may affect a bond’s investment value by resulting in lower bond prices or an eventual decrease in income. Treasury bonds are issued by the government of the United States. Payment of principal and interest is guaranteed by the full faith and credit of the U.S. government, and interest earned is exempt from state and local taxes. The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. 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 based on a combination of their market cap and current index membership. The Russell 2500™ Value Index measures the performance of the small to mid-cap value segment of the U.S. equity universe. It includes those Russell 2500 companies with lower price-to-book ratios and lower forecasted growth values. 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-to-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 based on 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 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. MSCI EAFE® Index is an unmanaged, market-weighted index of companies in developed markets, excluding the U.S. and Canada. Source: MSCI. 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. The U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS. The U.S. Aggregate rolls up into other Barclays flagship indices, such as the multi-currency Global Aggregate Index and the U.S. Universal Index, which includes high-yield and emerging markets debt. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. Indexes are unmanaged, and an investor cannot invest directly in an index. 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
