John Rogers Jr founded Ariel Investments in 1983 with seed money of barely 200 thousand dollars from his friends and family. Till date, this stretch of 28 years has rewarded his investors with 9% plus annual returns net of fees and the assets under management have grown to over 5 billion dollars. The fund is managed out of downtown Chicago, north of Hyde Park where Mr. Rogers Jr was born and brought up, and where till today he participates in three-on-three basketball tournaments (he confesses his luck on the basketball court outshines his skill, and, luckily for his investors, vice-versa in the stock markets).
Currently they offer four publicly-traded mutual funds: (1) the original flagship Ariel Fund, (2) Ariel Appreciation Fund that was started after six years from the original fund, (3) Ariel Focus launched in 2005, and (4) Ariel Discovery that was created in early 2011.
All the funds share the basic fundamentals of low-turnover, concentrated portfolios, and long-only equity value investing with variance on company sizes. More particularly, Ariel Fund invests in undervalued small to mid-sized companies and normally holds no more than 40 stock positions, Ariel Appreciation Fund exclusively emphasizes mid-cap companies with about 30 to 40 stocks, and Ariel Focus Fund holds a concentrated portfolio of around 20 stocks at a time of companies which usually have market capitalization of more than $10 billion. Ariel Discovery Fund, which still has to establish a track record, targets a portfolio involving 30 to 40 companies with small market capitalization only of under $2 billion.
The value-oriented (more like value-committed or -obsessed) investment philosophy with the variance on capitalization is best captured by their logo and name. The name Ariel has a dual meaning: the “Lion of God” that has a domineering presence in the fields (but is not, after all, God) and various gazelle-like antelopes that are small and known for their speed and nimbleness, thereby representing the mid-capitalized companies and the smaller ones (and the characteristic benefits of their sizes). (The dishonorable Mr. Madoff also had a feeder fund named Ariel which caused some unfortunate confusion for Mr. Rogers Jr’s investors at the time the Madoff Ponzi scheme was uncovered.)
The ubiquitous logo is a turtle showcasing a winner’s prize cup, an obvious reference to the slow albeit steady and patient tortoise that defeats the erratic hare in Aesop’s fable. In the same vein, Mr. Rogers Jr regularly writes a column for Forbes entitled the “Patient Investor”.
Further, each and every update for any of the four funds is punctuated with the same three quotes from renowned value investors Warren Buffet and Sir John Templeton. The first two quotes are from Warren Buffet, “Time is the friend of the wonderful company, the enemy of the mediocre” and “Invest within your circle of competence”. From Sir Templeton they borrow, “If you buy the same stocks as everyone else, you get the same results.”
These three quotes capture the essence of their investment style, which rigorously dominates the investment process from the incipient stages of research and ideation, the often vexing stage of holding the investment through volatility, and the final stage of harvesting the well-earned rewards.
In the pre-investment phase, the patient and focused outlook allows them the luxury of zeroing in on the right investments and performing intense research to establish that a true discount exists for a viable company with a definable moat (rather than a value trap in a declining company, often in a declining industry).
On the qualitative side of the analysis, they constantly interact with management of companies they are seeking to invest in, evaluating the management’s competence and meanwhile also creating domain expertise in the business. Rather than a general understanding of the company’s business, they delve deep into their sector and vertical niches and attempt to truly understand the fundamental drivers.
The quantitative aspect of the pre-investment analysis is fixated with filtering the idea through many software screens to establish the intrinsic discount in the stock. In order for the stock to become a purchase target, the stock has to be trading at a minimum 40% discount to their calculation of its Private Market Value and selling for no more than 13 times their forward cash earnings. Akin to many value investors, they also look for low debt, especially low debt-to-equity and low debt-to-capital ratios. Unlike other investors, the discount is sought in relation to their own proprietary calculation of private market capitalization (as opposed to valuations of publicly traded companies) and the earnings multiple is based on cash flow rather than the all-too-common accrued or other imaginary earnings. Of course, the deeper the discounts the better, as they always relish a comfortable margin of safety.
Having arrived at an investment idea with the above mix of quantitative and qualitative analysis, now they subject the idea to further scrutiny. They stress test the idea against their always developing network of industry experts and engage in deeper discussions with company management to pinpoint the major issues facing the company (as there always are issues for the discount and mispricing to be present in the market).
Then follows a series of intense internal discussions between the research analysts and the lead portfolio managers, the latter making the final call. If for whatever reason the investment idea is not deemed appropriate (say the margin of safety is not there, or the company’s moat or management’s commitment is questionable), then it is rejected without any emotion. If the qualitative aspect of the analysis passes muster and the only issues are in the quantitative side, then the fund follows the company, patiently waiting for the market to create the desirable mispricing.
Not only the fund under the stewardship of Mr. Rogers Jr engages in considerable patience in the pre-investment process, but also requires the same in harvesting its investments post-trade. Their investment time horizon is normally 3 to 5 years. There are two reasons for why they have to nurture their investment for this rather longish time period.
One, akin to any value investor that picks up a mispriced opportunity created by the short-term focused investors, it takes time for the market to rediscover the value in a company. In a typical situation, when a company misses its expected earnings or is spun off at a low valuation, first it takes the company time to get back to enjoying steady earnings or re-establish its value as an independent entity, and then it takes time for analysts to refocus on the earnings and value. As more and more analysts research the stock and create a buy rating, the stock price returns to a fair value and more.
Second, since the kind of discounts and market capitalizations the funds seek, their investments are often in industries that are obscure, under-researched or plain shunned by other momentum funds seeking to invest in hot sectors. For instance, in a recent column by Mr. Rogers Jr, “Boring All the Way to the Bank”, he discusses his “glamorous returns” from an investment in the “unglamorous outfit” of a company that deals in coffins. This distance from the focus of most Wall Street analysts results in a further drag for the time needed to return to fair value.
All the discipline and patience required in gathering the research to uncover a shunned opportunity and then invest in it, also plays a crucial role in the most important part of their investment process: holding the stock to fruition to higher value. While their focus on a concentrated portfolio is partially explained by the research process, it is truly required for them to have the ongoing contrarian conviction backed by precise knowledge to continue ignoring the noise of the misguided markets. It is one thing to have momentary independent thinking that spurs one to boldly invest in a contrarian idea, but to have the fortitude to stand firmly by that idea when it is further decimated by the markets tests the all too human emotion of fear. It is the process set up by Mr. Rogers Jr that accounts for the fund’s capacity to ignore the inevitable emotional swings experienced by most investors when in the middle of extreme volatility.
Interestingly, in 1999, when most value funds were not only doing poorly in absolute terms (double digit losses) but terribly relative to the general markets hooked on growth and even worse in relation to companies participating in the internet bubble, the flagship fund only lost 5%, and gained 28% and 14% in 2000 and 2002 respectively as value investment (some would argue, as always) came back in style.
But in the midst of the financial crisis in 2008, Mr. Rogers Jr could not avoid the volatility and the flagship fund lost 48%. While there naturally were some redemptions in the fund by nervous investors, Mr. Rogers Jr shifted into an “aggressive” buying mode and grabbed up as much value as he could. The new investments, along with the previous holdings, resulted in a 63% surge in the fund for the year of 2009. Not that any of the funds seek such returns in and out every year, but these two anomalous years helped the fund maintain its long-term record of 9% plus of 28 years.
Mr. Rogers Jr was born into a prominent Chicago family. His father was a Tuskegee airman who eventually became a circuit judge, and his mother was a partner in a Chicago Law firm with Republican ties.
Mr. Rogers Jr graduated with a BA in economics from Princeton and went on to work for William Blair & Co., a Chicago-based boutique investment banking firm. There he was the first one to be hired directly out of college and the first African-American professional in the firm. He left the firm in 1983, after barely three years, to found Ariel Capital Management with seed money of $200,000 from his family, and today the fund is the largest minority-owned money manager. Mr. Rogers Jr’s funds are socially responsible and do not invest in nuclear energy, defense contractors, guns/weapons manufacturers and cigarette companies.
In accordance with his belief in understanding companies, Mr. Rogers Jr spreads his knowledge to other businesses beyond Ariel Investments by sitting on the boards of reputable corporations. Currently he serves as Chairman of the Finance Committee and as a member of the Governance/Nominating Committee of Aon Corporation, and is also a director at Exelon Corp and McDonald’s Corp.
He was recently honored with the title of Outstanding Director by the Outstanding Directors Exchange to distinguish his leadership style in terms of compliance, management and diversity in the boardroom.
“The problem is that most investors do not view negative returns and extreme volatility opportunistically. As self-proclaimed Buffett wannabees, we have been doing just that!”
“The Greek poet Homer once said, “Adversity has the effect of eliciting talents which in prosperous circumstances would have lain dormant.” In recent years, stock market investing has been a testament to adversity. For some, this kind of hardship discourages and defeats. For us, it enlightens and emboldens.”
“An unemotional response is the right one in many critical moments—be it the game-winning shot or a life-saving procedure. But it’s hard to hold it together in a crisis. If you keep your wits and buy during panics, the rewards can be outsized.”
“In fact, sharp downswings offer the chance to buy great companies at bargain prices.”
I asked 71 of my associates to pick ten stocks that would underperform the market in the second quarter. Only 19 of them succeeded, meaning 73% of them tried to lose on purpose but couldn’t. Indeed, the average return on the try-to-lose portfolios was 30%, double the market’s return. The lesson: Short-term stock movements are more a function of luck than skill.
“I tend to be patient with winners as well as losers.”
“Investors should want a skillful manager, not a lucky one. But there are only a small percentage of money managers who are truly skillful. There are a few people who really rise to the top. Being a skillful manager — I think a lot of it is innate. It’s the ability to see the future. It’s a gift. Some people have the ability to see how things will play out before they happen, like great musicians, great artists and the best athletes.”
“You have to stay within circle of competence and know the industry well. You want high- quality companies. You want to look at the management team, visit with them, understand their vision and their plans. You have to evaluate that management team. You also want to look for companies with a moat around it, where there’s less competition, companies with high returns on capital, not too highly cyclical. You want some good, consistent, growing companies.”