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John Rogers' Ariel Fund 1st Quarter Shareholder Letter

- By Holly LaFon

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 Fund invests may never be recognized by the broader market. Ariel Fund is often concentrated in fewer sectors than its benchmarks, 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. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com. For the period ended March 31, 2019, the average annual total returns of Ariel Fund for the 1-, 5-, 10-year periods were +0.70%, +7.88%, and +18.54%, respectively. For the year ended September 30, 2018, the Fund's Investor Class shares had an annual expense ratio of 1.01%.

Quarter Ended March 31, 2019


U.S. markets delivered a banner first quarter, with large cap stocks within the S&P 500 delivering their best showing since 2009, followed by small cap stocks within the Russell 2000 Value Index posting their best start to the year since 1992. Compelling broad market valuations, optimism on trade negotiations and a dovish pivot from the Federal Reserve and other central banks have investors looking to 2019 with positive sentiment. Markets are also rallying around the belief that the U.S. continues to be a relative bright spot in the global marketplace. Uncertainties surrounding Brexit have shaken the United Kingdom and economic growth has cooled from the Eurozone to China. So while the U.S. economy is not breaking any records, it remains steady, and that has helped boost investor confidence. Ariel Fund advanced +17.59% during the quarter, significantly outperforming the Russell 2500 Value Index and the Russell 2500 Index, which returned +13.12% and +15.82%, respectively.


Several stocks in the portfolio had strong returns in the quarter. Producer and supplier of sand, U.S. Silica Holdings, Inc. (SLCA) advanced +71.22% during the quarter. SLCA delivered a solid earnings report highlighted by record full year revenues and adjusted EBITDA for the company; record contribution margin dollars and contribution per ton for its Industrial business; record volumes of sand proppant sales driven by an enhanced customer and product mix; as well as meaningful contributions from the acquisition of EP Minerals. Additionally, SLCA's SandBox Logistics(TM) business unit--a key part of our investment thesis--won several patent claims in the quarter that cover fundamental aspects of the technology, reaffirming the strength of its intellectual property and broad patent portfolio. Looking ahead, SLCA expects to substantially grow the Industrial segment by focusing on Specialty Minerals and Performance Material offerings. SLCA is also excited about the prospects for SandBox in 2019 and beyond, as the existing equipment is already sold out for the coming year, and the company is building new equipment as fast as it can to meet strong customer demand and exceed its market share projections.


Waste management services provider, Stericycle, Inc. (SRCL) increased +48.32% in the period. SRCL delivered earnings that were modestly above Wall Street expectations driven by strength in its core Secure Information Destruction business and positive momentum in the regulated medical waste business. Additionally, as part of its ongoing efforts to ensure SRCL has the skills and expertise necessary to drive performance and execute its Business Transformation goals, the company recently added several new executives to its leadership team, including a new Chief Executive Officer, Chief Commercial Officer, and will be appointing a new Chief Financial Officer. Looking ahead, we continue to view SRCL as a solid franchise with stable long-term growth prospects, including margin expansion opportunities and strong free cash flow generation resulting from ongoing strategic transformation initiatives.


Bar code manufacturer, Zebra Technologies Corporation (ZBRA) traded +31.59% higher during the quarter. Broad based demand both geographically and by product drove a top and bottom line earnings beat. ZBRA's business model has become diversified across products and verticals over the past few years. While the stock trades an impressive 260% higher than its 2016 bottom, we believe there is still more upside to come. Specifically ZBRA's nascent opportunity in the healthcare space, the deferment and runway of Android refresh cycles, as well as the potential to create value through capital allocation. As evidenced by our heavy weighting in the portfolio, we continue to like everything about this story.


Other holdings underperformed in the quarter. Owner and operator of regional sports and entertainment networks, MSG Networks, Inc. (MSGN) declined -7.68% in the quarter, mainly on news surrounding Walt Disney Co.'s (DIS) forced sale of the recently acquired 21st Century Fox's regional sports networks "RSNs". The market is using this transaction, which includes YES Network, as a benchmark for MSGN's valuation. The situation continues to be fluid and visibility is limited given the absence of official commentary from DIS and unconfirmed sources cited by the press. Aside from the pending RSN sale, the market has been focused on MSGN's ability to successfully renegotiate affiliate agreements with linear distributors, gain incremental distribution on virtual multichannel providers and demonstrate subscriber growth. In response, management noted a major renewal in early 2019. At current levels, MSGN is trading at a 40% discount to our estimate of private market value.


Financial advisory and traditional asset management firm Lazard, LTD. (LAZ) increased +0.43% during the quarter. However, because the name underperformed its financial peer group, our position negatively impacted relative returns by - 40 basis points. Record earnings results for 2018 were neutralized by investor concerns about the global economic, regulatory and political landscape. Specifically, LAZ is the leader in cross-border merger and acquisition advisory in Europe, which has been materially impacted by the ongoing confusion surrounding Brexit. Transactions have been delayed until further clarity is reached, although the related drama will actually serve to spur demand as companies will need guidance on how to navigate the new rules and regulations once the situation is settled. At $4.23 forward cash EPS and a 46% discount to our estimate of private market value, we continue to believe shares are undervalued.


Leading global provider of data and analytics about what customers watch and buy, Nielsen Holdings Plc. (NLSN) finished the quarter up +2.81%, however because the company underperformed its consumer discretionary peers, it negatively impacted relative returns by -27 basis points. While NLSN's Board of Directors continues to review strategic alternatives, we believe our thesis in the name remains mostly intact. We underestimated the competitive intensity for the Buy business in emerging markets, however the Watch business continues to be solid. At today's valuation, we see the risk/reward skewed sharply to the upside. With new management in place, an engaged board and a well-respected activist investor involved, we remain optimistic that decisive actions will be taken to fully realize the value of its sum-of-the-parts.



We initiated a position in Molson Coors Brewing Co. (TAP). The company has a strong portfolio of brands and growing mix of products, which we expect will result in greater top line growth, profitability and market share gains over the long term. There were no exits during the quarter.


Although U.S. economic data has generally softened in the first quarter, we remain cautiously optimistic that its lightly regulated free market system will continue to generate stable but healthy economic growth and positive returns over the long-term. In the meantime, we expect many of our domestic holdings to benefit from steady economic and modest corporate earnings growth, as well as tailwinds from the stimulus effect of U.S. tax reform. The bull-run, it seems, is here to stay for now. The drivers appear sustainable and investor sentiment is not yet euphoric. Short-term corrections and market volatility are expected in the near-term--be it from profit taking, corporate earnings swings, elevated corporate debt leverage, trade policy or geopolitical factors. That said, we view these uncertainties and risks as short-term noise within the context of our long-term investment horizon.

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 03/31/2019, U.S. Silica Holdings, Inc. constituted 3.0% of Ariel Fund; Stericycle, Inc. 3.3%; Zebra Technologies Corporation 3.8%; MSG Networks, Inc. 2.9%; Lazard Ltd 3.5%; Nielsen Holdings Plc 2.8%; and Molson Coors Brewing Co. 1.7%. 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.


Index returns reflect the reinvestment of income and other earnings. Indexes are unmanaged, and investors cannot invest directly in an index. The Russell 2500(TM) Value Index measures the performance of the small to mid-cap value segment (companies with lower price-to-book ratios and lower forecasted growth values) of the U.S. equity universe. The Russell 2500(TM) Index (a subset of the smallest 2500 companies of the Russell 3000(R) Index) measures the performance of the small to mid-cap segment of the U.S. equity universe. Frank Russell Company ("Russell") is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell(R) is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes or underlying data and no party may rely on any Russell Indexes and/or underlying data contained in this communication. No further distribution of Russell data is permitted without Russell's express written consent. Russell does not promote, sponsor or endorse the content of this communication. The S&P 500(R) Index is the most widely accepted barometer of large cap U.S. equities. It includes 500 leading companies.

This article first appeared on GuruFocus.