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Fund name: Ariel Focus (ARFFX)

Objective: Non-diversified, mid- to large-cap domestic value fund. Generally speaking, the fund will invest in 20 stocks with a market cap in excess of $10 billion each; half of those stocks will be drawn from the portfolios of Ariel Fund or Ariel Appreciation. Ariel funds favor socially-responsible company management; the firm avoids tobacco, nuclear power and handgun companies. Ariel argues that such corporations face substantial, and substantially unpredictable, legal liabilities.

Adviser: Ariel Capital Management, LLC. Ariel manages $19 billion in assets, with $8 billion in its two veteran mutual funds. Ariel provides a great model of a socially-responsible management team: the firm helps run a Chicago public charter school, is deeply involved in the community, has an intriguing and diverse Board of Trustees, is employee-owned, and its managers are heavily invested in their own funds. One gets a clear sense that these folks aren’t going to play fast and loose either with your money or with the rules.

Manager(s): Investment team led by Charlie Bobrinskoy (Ariel’s Vice Chairman and Director of Trading, previously with Salomon/Citigroup), and Tim Fidler (Ariel’s Director of Research).

Opening date: It varies. The firm ran in-house money using this strategy from March 1 through June 29 2005. The fund was offered to Illinois residents and Ariel employees beginning June 30, 2005. It became available nationally on February 1, 2006.

Minimum investment: $1000 for regular accounts, $250 for an IRA. The minimum is waived for investors establishing an automatic monthly investment of at least $50.

Expense ratio: 1.25% (after expense waiver). Ariel estimates that first-year expenses would be 2.55% without the waiver. The waiver expires September 30th, 2006, but such waivers are generally renewed.

Comments: This is the latest entrant into the “I want to be like Warren Buffett” sweepstakes. I had the opportunity to speak with Tim Fidler, one of the co-managers, and he’s pretty clear that Mr. Buffett provides the model for Ariel investing, in general, and Ariel Focus, in particular. The managers are looking for companies with a sustainable economic advantage -- Mr. Buffett calls them companies with “moats.” Ariel looks for “high barriers to entry, sustainable competitive advantages, predictable fundamentals that allow for double digit earnings growth, quality management teams, [and] solid financials.” In addition, Ariel espouses a concentrated, low-turnover, low-price style. Mr. Fidler had been reading Artisan Opportunistic’s materials and was struck by many similarities in the funds’ positioning; he characterized his fund as likely “more contrarian,” which might suggest more patience and longer holding times. (Artisan Opportunistic was discussed in last month's FundAlarm Annex.)

Ironically, for all of the Buffett influence, there’s no overlap between Buffett's (i.e., Berkshire Hathaway's) 32-stock portfolio and the 20 stocks in Ariel Focus.

What might drive your investment consideration with Ariel Focus? Two factors:

1. It’s a concentrated, non-diversified portfolio. That should, in theory, drive risk and return higher. In practice, the evidence for either proposition is mixed. There are four firms that each offer two funds with the same managers and the same value philosophy, one diversified and one focused. They are Oakmark/Select, Yacktman/Focused, ICAP Equity/Select, and Clipper/Focus (yes, I know, there's been a recent manager change, but most of the three-year record was generated by the same management team). Generally speaking, the focused fund has exhibited higher volatility, but only by a little (the standard deviations for Oakmark and Oakmark Select are typical: 8.2% versus 8.9%). The question is whether you’re consistently paid for the greater risk,and the answer seems to be “no.” There’s only one of the four pairs for which the Sharpe ratio (a measure of risk-adjusted returns) is higher for the focused fund than for the diversified one. The differences are generally small but have, lately, favored diversification.

2. The fund is building off a solid foundation. In general, 50% of the Focus portfolio will be drawn from names already in Ariel or Ariel Appreciation. Those are both solid, low-turnover performers with long track records. Focus will depend on the same 15 person management team as Ariel; most of those folks are long-tenured and schooled in Ariel’s discipline. Their task is to apply a fairly straightforward discipline to a limited universe of new, larger stocks, about 90 companies, in all. If they’re patient, it should work out. And they do have a reputation for patience (their corporate motto, after all, is “slow and steady wins the race”).

Bottom line: if you believe in buying and holding the stocks of good, established companies, this is an entirely worthwhile offering. The advisor’s high standards of corporate behavior are pure gravy.

Company link: Ariel Focus (Ariel Web site)

May 1, 2006

Update (posted September 1, 2008):

Assets: $40 million

Expenses: 1.25%

YTD return: (4.8%)(as of 8/29/08)

 

Ariel Focus has been slowly gaining traction. Its first year (2006) was a disaster as the fund trailed 97% of its peers and 2007 was only marginally better with the fund trailing 79% of its peers. 2008 has been a different story, with the fund now leading 97% of its peers. That performance has helped the fund move back to the middle of the pack, with a three-year annual return of 2.3%.

The managers attribute most of their recent success, which began in the second half of 2007, to the hard-hit financial sector. Financials helped ARFFX because (1) they didn’t own many of them and (2) the companies they did hold – Berkshire-Hathaway, JPMorgan, Aflac – weren’t involved in the most-toxic part of the mess. They were also helped by the managers’ skepticism about the durability of the commodity and oil bubble, which has helped its consumer holdings in the past several months.

Unfortunately the fund’s improving fortunes haven’t been enough to forestall layoffs at Ariel. The company is celebrating its 25th anniversary this year but the party’s a bit bittersweet since it’s accompanied by the loss of a contract to manage part of Massachusetts’ retirement fund and the laying off of 18 staff members.