On the heels of a very strong 2017, the first quarter provided an unwelcomed wake up call to those who may have been lulled into believing the stock market’s upward trajectory was unstoppable. In many ways, the simultaneous fears that rising inflation and/or escalating protectionism might break out into something more serious and destabilizing started to take shape. Accordingly, as The Wall Street Journal noted, “The first three months of 2018 were a volatile period, culminating in the S&P 500’s first quarterly loss since mid-2015.”¹ Although this -0.76% shortfall was minor by most standards, it did usher in a new wave of Wall Street consternation.

“As passive funds are forced to own popular and expensive issues like the FANG gang…other areas are starved for attention.”

Against this backdrop, for the quarter ending March 31, 2018, the Ariel Fund gained +0.80% during a time when the smaller companies comprising the Russell 2500 Value Index fell -2.65% and the more style neutral Russell 2500 Index modestly declined -0.24%. And although the Ariel Appreciation Fund outperformed its primary benchmark over the three month period—it did post a tiny loss. More specifically, the Ariel Appreciation Fund fell -0.46% versus-2.50% for the Russell Midcap Value Index and -0.46% for the Russell Midcap Index.

Across both funds, the areas of strength and weakness were largely the same. In the Ariel Fund, positive contributions from our Producer Durables holdings were offset by softness in the Materials and Processing sector—namely U.S. Silica Holdings, Inc. (SLCA)—a stock that we still like and continue to hold. Similarly, our Financial Services names boosted returns. Both areas more than made up for our one Technology sector stock which marginally detracted from results. That same security—Anixter International, Inc. (AXE)—slightly nicked the

Ariel Appreciation Fund’s results but its minor detraction was balanced by nice gains amongst our financial holdings.

TO DIE FOR

As natural contrarians, nothing gets us more excited than the occasional—but often predictable—article that ponders the potential demise of one of our time-tested underpinnings. We say “often predictable” because whenever there is any kind of performance dispersion between growth and value, or stocks and bonds, or large and small companies, the “this time is different” crowd re-emerges. On this point, we often recall the famous “Death of Equities” BusinessWeek cover story that appeared to be perfectly timed to usher in one of the best performing bull markets of the 20^th Century.² In that same vein, Barron’s offers an in-depth cover story entitled “Are Value Stocks Ready to Grow Again?”³ While the article’s title is promising, the piece considers a more dire circumstance. More specifically, it notes, “…since 2006, growth stocks—shares of companies whose earnings are growing at an above-average rate—have outpaced value stocks, especially in the U.S. This has caused consternation and speculation: Is value dead?”⁴

The willingness to consider this possibility arises from the widening performance gap between growth and value indices over the last decade. More specifically, as shown on the chart below, growth trounces value. It is worth noting that we are pleased to see our patient approach beat our value indices.

10 year snapshot as of 3/31/18

		10 years cumulative
Ariel Fund Investor Class | ARGFX			165.98%
Russell 2500TM Value Index			144.33%
Russell 2500TM Growth Index			188.44%
Ariel Appreciation Fund Investor Class | CAAPX			169.34%
Russell Midcap® Value Index			154.94%
Russell Midcap® Growth Index			174.17%
S&P 500® Index			147.71%

Past performance does not guarantee future results.

TWO ROADS

While both growth and value alternatively have their moments in the sun, a 1992 paper by famed University of Chicago Economists, Eugene Fama and Kenneth French, parsed decades of data and ultimately concluded that over the longer term, value holds the edge.⁵ Of course, theories have emerged about why this performance pattern has become undone of late. Perhaps the strongest case for growth’s recent dominance is the surge in passive investing. According to Barron’s, “As money poured into market capitalization-weighted indexes, the priciest stocks became even more so, while the neglected stocks in value investors’ portfolios became further unloved.”⁶ As passive funds are forced to own popular and expensive issues like the FANG gang (Facebook, Amazon, Netflix and Google), other areas are starved for attention. This divergence was further exacerbated by the sector biases of the value and growth indices. With value indices heavily weighted in relatively poorer performing sectors like Financials and Energy, and growth indices super charged by their high octane Technology shares, two roads have diverged in the woods. The value managers are taking the one less traveled and therein lies the upside in our view.

“Two roads have diverged in the woods. The value managers are taking the one less traveled and therein lies the upside in our view.”

Our optimistic perspective is not rooted in a convenient “reversion to the mean” theory—although one could theorize that such an occurrence is likely to also drive future returns. Instead, our enthusiasm is actually fueled by a number of positive signs. First, despite a strong market run, our funds remain cheap. We believe both Ariel Fund and Ariel Appreciation Fund sell at a discount to their core and value benchmarks. Second, because “the gap between the cheapest and priciest stocks has also widened since last

year…”⁷, we continue to find plenty to buy. In the past, when bull markets got to be long in the tooth, deploying cash became a challenge. But these days, our new idea pipeline is full. Lastly, while counterintuitive, we are actually encouraged by the fact that the biggest asset gatherers in the last decade have simultaneously been commoditizing the market. More specifically, today’s index fund behemoths are the “Amazons” of the financial services world—fast growing, enormous and cheap. And even if these organizations continue to play a large role in the future of the money management and mutual fund industry (as we believe they will), commoditization makes anything that is different stand out. As such, in a growth fueled market, value becomes more conspicuous.

“We continue to find plenty to buy…our new idea pipeline is full.”

We have been navigating markets for nearly 35 years now. Over this extended period, we have lived through a myriad of investment environments—bull and bear markets, growth and value dominance, large cap and small cap leadership. We have ultimately survived and thrived by staying focused on the ground game, not the clouds. Building portfolios one stock at a time. Concentrating on the long-term while ignoring the noise. The current period will not last forever. And when the balance shifts, we do believe our portfolios are well positioned for all that lies ahead.

PORTFOLIO COMINGS AND GOINGS

We did not exit any positions in Ariel Fund or Ariel Appreciation Fund this quarter. However, in both funds, we purchased Oaktree Capital Group, LLC (OAK), a leading global alternative investment management firm. Oaktree is one of the largest and most successful alternative investment firms in its industry. While the performance of alternatives has been static over the years, Oaktree has been focusing on its restructuring business which is countercyclical. We continue to believe the company’s fundamentals are solid

and the market will reassess the name. In Ariel Appreciation Fund, we also opened a position in Stericycle Inc. (SCRL), a waste management company. We were attracted to Stericycle given its wide economic moat, best-in-class management team and solid growth prospects. The stock has been sold off by growth managers, but has not yet been appreciated by value managers. As contrarian, patient investors, we are always looking beyond the pack.

“We have been navigating markets for nearly 35 years now. We have ultimately survived and thrived by staying focused on the ground game, not the clouds.”

As always, we appreciate the opportunity to serve you and welcome any questions or comments you might have. You can also contact us directly at [email protected].

 

Sincerely,
John W. Rogers, Jr.		Mellody Hobson
Chairman and CEO		President

 

John W. Rogers, Jr.		John P. Miller, CFA		Kenneth E. Kuhrt, CPA
Lead portfolio manager		Portfolio manager		Portfolio manager

Composition of equity holdings (%)

		Ariel  Fund†		Russell 2500 Value Index		Russell 2500 Index		S&P 500 Index
Financial services		29.65		39.67		27.07		19.99
Consumer discretionary		29.42		10.85		13.55		14.05
Producer durables		20.16		13.19		15.55		10.62
Health care		5.85		5.56		11.76		13.57
Materials & processing		4.81		7.09		7.65		3.06
Consumer staples		3.06		2.99		2.54		6.52
Technology		2.18		6.57		13.45		21.67
Energy		0.46		7.36		4.41		5.74
Utilities		0.00		6.72		4.01		4.78

†	Sector weightings are calculated based on equity holdings as a percentage of total net assets.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

10-year

20-year

Since inception

Ariel Fund–Investor Class

+ 0.80

+   9.62

+   6.67

+ 12.41

+ 10.28

+ 8.74

+ 11.44

Ariel Fund–Institutional Class+

+ 0.87

+   9.93

+   6.98

+ 12.75

+ 10.49

+ 8.84

+ 11.51

Russell 2500TM Value Index

– 2.65

+   5.72

+   7.26

+   9.88

+   9.34

+ 8.60

+ 11.21

Russell 2500TM Index

– 0.24

+ 12.31

+   8.15

+ 11.55

+ 10.28

+ 8.57

+ 10.85

S&P 500® Index

– 0.76

+ 13.99

+ 10.78

+ 13.31

+   9.49

+ 6.46

+ 10.35

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

Expense ratio (as of 9/30/17)

 

Investor Class		1.01%
Institutional Class		0.71%

Top ten equity holdings (% of net assets)

 

		1.		KKR & Co. L.P.			4.3				6.			Keysight Technologies, Inc.			3.5
		2.		Zebra Technologies Corp.			4.1				7.			JLL			3.4
		3.		MSG Networks, Inc.			3.9				8.			Kennametal, Inc.			3.2
		4.		Lazard Ltd., Class A			3.8				9.			Northern Trust Corp.			3.1
		5.		First American Financial Corp.			3.6				10.			J.M. Smucker Co.			3.1

John W. Rogers, Jr.		Timothy R. Fidler, CFA
Co-portfolio manager		Co-portfolio manager

Composition of equity holdings (%)

		Ariel Appreciation Fund†		Russell Midcap Value Index		Russell Midcap Index		S&P 500 Index
Financial services		31.36		35.18		27.34		19.99
Consumer discretionary		24.18		12.40		14.68		14.05
Producer durables		18.34		10.85		13.40		10.62
Health care		14.77		6.37		9.07		13.57
Consumer staples		4.52		3.70		3.92		6.52
Energy		2.52		8.37		5.66		5.74
Materials & processing		1.83		6.51		6.93		3.06
Technology		0.81		5.90		12.98		21.67
Utilities		0.00		10.72		6.01		4.78

†	Sector weightings are calculated based on equity holdings as a percentage of total net assets.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

10-year

20-year

Since inception

Ariel Appreciation Fund–Investor Class

– 0.46

+   6.72

+   5.08

+ 10.62

+ 10.42

+ 8.72

+ 10.78

Ariel Appreciation Fund–Institutional Class+

– 0.37

+   7.06

+   5.41

+ 10.98

+ 10.63

+ 8.82

+ 10.85

Russell Midcap® Value Index

– 2.50

+   6.50

+   7.23

+ 11.11

+   9.81

+ 8.98

+ 11.46

Russell Midcap® Index

– 0.46

+ 12.20

+   8.01

+ 12.09

+ 10.21

+ 8.93

+ 11.34

S&P 500® Index

– 0.76

+ 13.99

+ 10.78

+ 13.31

+   9.49

+ 6.46

+   9.70

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

Expense ratio (as of 9/30/17)

 

Investor Class		1.12%
Institutional Class		0.82%

Top ten equity holdings (% of net assets)

 

		1.		J.M. Smucker Co.			4.5				6.			Aflac, Inc.			3.8
		2.		First American Financial Corp.			4.2				7.			Interpublic Group of Cos., Inc.			3.7
		3.		Keysight Technologies, Inc.			4.1				8.			Zimmer Biomet Holdings, Inc.			3.6
		4.		Laboratory Corp. of America Holdings			4.1				9.			Lazard Ltd., Class A			3.2
		5.		Northern Trust Corp.			3.9				10.			Stanley Black & Decker, Inc.			3.2

For the first quarter ended March 31, 2018, Ariel Focus Fund lost -0.80%, outperforming its primary Russell 1000 Value benchmark which dropped -2.83%, and falling in line with the S&P 500 which declined -0.76%. As patient investors, we always focus on long-term performance rather than short-term fluctuations. Nevertheless, it is encouraging to see the portfolio hold up in a challenging market.

WHAT HELPED AND HURT?

First, a review of the companies having the largest impact in the quarter, both positively and negatively. Zebra Technologies Corp. (ZBRA), Adtalem Global Education, Inc. (ATGE) and Lockheed Martin Corp.

(LMT) contributed the most to performance. Barrick Gold Corp. (ABX), Snap-on, Inc. (SNA) and Zimmer Biomet Holdings, Inc. (ZBH) were the largest detractors. In 2016, Focus Fund initiated a position in Zebra. At that time, the company was trading at a very attractive 10 times forward earnings after declining over -40% on concerns about the future of brick and mortar retailing. Zebra makes bar code printers and scanners used to track the location and quantity of products throughout the manufacturing process. Wall Street became concerned retailers, where inventory management is critical, would curtail their purchases of the company’s products due to competitive challenges from Amazon.com, Inc. (AMZN)

and other online retailers. We acknowledged the issue, but believed these fears were more than reflected in Zebra’s stock price. Its shares increased +34.09% in the first quarter and trades at $135.13 as we go to press today. E-commerce has grown in strategic importance for traditional brick and mortar retailers, even those who are struggling. Inventory management and on-line fulfillment have generated increasing demand for Zebra’s products. A perceived headwind has become a tailwind.

Adtalem Global Education, Inc. (ATGE), the renamed DeVry Inc., increased +13.08% over the last three months. When I repurchased shares in the company after Election Day 2016, the investment thesis was simple. I believed the regulatory environment for for-profit education companies was going to meaningfully improve. Since then, our thesis played out as expected.

Lockheed Martin Corp. (LMT) returned +5.86% in the quarter. The company’s F-35 is proving to be one of the most successful defense systems ever developed with sales of at least $1.5 trillion (that’s trillion with a “t”) over the projected life of this advanced fighter.

On the down side, Barrick Gold Corp. (ABX) continued to underperform. The company had a tough 2017 mostly due to problems in Argentina and Tanzania. An important pipe burst at its Veladero mine in Argentina which caused safety and environmental issues. Production was curtailed and relations with local government authorities were impaired. While the mine is now up and running, it is operating at lower levels of profitability. In Tanzania, the local government imposed harsh restrictions on exports, effectively forcing Barrick to cede a greater portion of its profits. Mostly because of these two factors, Barrick issued disappointing guidance in February, causing the stock to fall -13.74% in the quarter. On the positive side, the company has continued to generate substantial cash flow and has paid down debt. In March, S&P upgraded the company’s credit rating to BBB. Gold and copper prices have continued to trend higher and will be helped by inflationary concerns or a weaker dollar. We are maintaining our investment in the company.

Snap-on, Inc. (SNA) declined -14.90% in the quarter. The recent “re-rating” of this leading manufacturer,

distributor and financer of automotive tools has been remarkable. As you may know, I exited my position in Snap-on in February of 2015 at a price of $147.09. I reinitiated a position in July 2017 at almost exactly the same price, $147.57. I repurchased shares at virtually the same price because Snap-on is a lot more profitable today and generates significantly more earnings. In 2015, the company recorded fully diluted earnings per share of $8.10. With subsequent growth in the company’s sales and operating profit, plus a substantially lower tax rate, we estimate Snap-on will earn EPS of $11.68 over the next twelve months. That is 44% more earnings at essentially the same price. The chart below depicts Snap-on’s plummeting PE ratio despite the earnings growth. As such, we have been adding to our position.

 

 

Zimmer Biomet Holdings, Inc. (ZBH) was the third largest detractor in the quarter, declining -9.44%. Our thesis on Zimmer continues to be straight forward. An aging North American population with increasing obesity rates will produce more demand for hip and knee replacements. Not to mention, surgeons are reluctant to shift between orthopedic brands which reduces pricing pressure. Unfortunately, Zimmer’s acquisition of rival Biomet has been troubled as legacy Biomet plants faced FDA regulatory scrutiny. As a result, Zimmer continues to struggle to meet product demand. Worried investors fear frustrated doctors might switch to competitors. Our work indicates that customers are remaining loyal so far. But the company will need to improve manufacturing capacity to meet our earnings’ expectations. We reduced our position modestly last year.

PORTFOLIO COMINGS AND GOINGS

We had higher than normal turnover in the first quarter—exiting two long-term holdings and initiating three new positions. We sold J.P. Morgan Chase & Co. (JPM) when the stock reached our calculation of intrinsic value. Having owned J.P. Morgan since the Fund’s inception, I have been quite public in my praise for my former boss, Jamie Dimon, whom I have called the greatest banker since J. Pierpont Morgan himself. Unfortunately, that admiration for the bank and its leader is no longer contrarian. Once the stock became fully valued, I sold our position at a very nice profit.

“Recent volatility has underscored the importance of trusting our valuations and process despite market disruptions.”

The ending was not nearly as happy for our investment in International Business Machines Corporation (IBM), another company we have owned since the Fund’s launch. From 2005 through 2012, the company performed admirably as management reduced costs, grew its traditional software, hardware and consulting businesses, and used cash flow to repurchase shares. This began to change in 2012 when new management started to sell slower growth, though still profitable businesses, often at unattractive prices. The promise of renewed growth from Watson and “big data” always seemed to be just over the horizon. In hindsight, we paid too much attention to IBM’s low PE and the contrarian nature of our thesis. Sometimes a stock is cheap for a reason. Sometimes management’s loss of credibility with Wall Street is deserved. We take some solace from knowing Warren Buffett made the same mistake. Misery loves company.

We added three new companies in the quarter, an unusually high number for the Ariel Focus Fund. Volatility produces opportunity when companies are unfairly punished. Such was the case with Nielsen Holdings plc (NLSN), Stericycle Inc. (SRCL) and an old Ariel favorite, Viacom, Inc. (VIAB). Although we have admired Nielsen for more than a decade, its shares were too expensive.

More recently, the company’s shares have been pressured. Its “buy business” (the service Nielsen performs for branded consumer companies to track sales) has lost share to Information Resources, Inc. The company’s larger “watch business” through its branded Nielsen Ratings remains strong and growing. Stericycle Inc. (SRCL) is also a “fallen angel” with its stock price cut in half since 2015. Stericycle has long enjoyed a premium market valuation due to excellent margins in its core medical waste business. Recent acquisitions have produced accounting problems and a new SAP information system will be expensive. We believe the company is still well governed, and will get through this investment cycle and return to strong earnings growth. The short-term, however, could be choppy. Finally, we initiated a position in Viacom’s Class B shares. At less than 8 times forward earnings and an enterprise value to EBITDA less than 8, we enter Viacom “eyes-wide-open” to the challenges of cord cutting and digital advertising. That said, the company is strong and growing overseas and Paramount remains a valuable asset. We estimate the company’s intrinsic value to be more than $50 per share, making its current stock price in the low 30’s a bargain. Recent volatility has underscored the importance of trusting our valuations and process despite market disruptions. As long-term investors, we remain committed to realizing opportunities in great companies.

As always, we appreciate the opportunity to serve you and welcome any questions or comments you might have. You can also contact us directly at [email protected].

Sincerely,

 

 

Charles K. Bobrinskoy

Portfolio manager

 

Charles K. Bobrinskoy

Portfolio manager

Composition of equity holdings (%)

		Ariel Focus Fund†		Russell 1000 Value Index		S&P 500 Index
Financial services		25.54		31.84		19.99
Health care		16.60		13.63		13.57
Producer durables		15.07		7.82		10.62
Consumer discretionary		13.28		8.32		14.05
Energy		9.06		10.80		5.74
Materials & processing		7.56		3.23		3.06
Technology		4.74		8.68		21.67
Consumer staples		3.21		6.96		6.52
Utilities		0.00		8.72		4.78

†	Sector weightings are calculated based on equity holdings as a percentage of total net assets.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

10-year

Since inception

Ariel Focus Fund–Investor Class

– 0.80

+   6.60

+   6.11

+   9.45

+ 6.72

+ 5.96

Ariel Focus Fund–Institutional Class+

– 0.73

+   6.88

+   6.38

+   9.73

+ 6.89

+ 6.09

Russell 1000® Value Index

– 2.83

+   6.95

+   7.88

+ 10.78

+ 7.78

+ 7.38

S&P 500® Index

– 0.76

+ 13.99

+ 10.78

+ 13.31

+ 9.49

+ 8.70

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

 

Expense ratio (as of 9/30/17)1		Net		Gross
Investor Class		1.00%		1.19%
Institutional Class		0.75%		0.90%

Top ten equity holdings (% of net assets)

 

		1.		Laboratory Corp. of America Holdings			5.0				6.			Lockheed Martin Corp.			4.3
		2.		BorgWarner, Inc.			5.0				7.			Barrick Gold Corp.			4.2
		3.		Oracle Corp.			4.7				8.			Hanger, Inc.			4.2
		4.		KKR & Co. L.P.			4.6				9.			Western Union Co.			3.9
		5.		Lazard Ltd., Class A			4.5				10.			Zimmer Biomet Holdings, Inc.			3.8

Last year, we cited a Wall Street Journal article highlighting the extended underperformance of the kind of low price-to-book value stocks that we favor.¹ In the first quarter of this year, these strong headwinds continued, leaving our niche of very small stocks deeply out of favor. Despite this challenging environment, our long-term confidence in small- and micro-cap asset-focused investing has not wavered. With company fundamentals generally strong, we believe our portfolios have become increasingly attractive, with untapped value at hand.

IF WE COULD OWN JUST ONE STOCK, WHAT WOULD IT BE?

We have tackled this question annually since 2011. Although we would never advocate a one stock portfolio, a detailed answer effectively illustrates our particular investment approach. As a reminder, we search for companies trading at an entry point that provides a potential “margin of safety.”* We seek protection in asset values, with an emphasis on pristine balance sheets. We want to be invested alongside talented and properly

incentivized leadership, and we look to identify upside potential from underappreciated opportunities and/or overlooked assets.

Century Casinos, Inc. (CNTY) is a developer and operator of mid-size casinos in regulated markets around the world. Regulated markets are preferred as they limit new entrants, while management’s experience helps the company navigate successfully. Century focuses on venues that combine gaming and entertainment, attracting locals and tourists alike. The company’s market capitalization at the quarter-end price of $7.46 was $219 million.

“Our long term confidence in small- and micro-cap asset-focused investing has not wavered.”

BETTING ON GREAT LEADERSHIP

Erwin Haitzmann and Peter Hoetzinger have been with the company since it was founded in 1993, and have served as Co-CEO’s since 2005. This unusual arrangement works quite well, largely because they were together at Casinos Austria prior to Century. Moreover, each owns well over one million shares, with option holdings taking both above the 5% ownership threshold. The pair’s shareholder mentality, unique insights into international gaming, and prudent approach, blended with ambitious goals, makes them among the best partners in our portfolios.

Despite outstanding long-term fundamentals, recent short-term fears have left Century’s shares extremely undervalued. At 1.2 times a likely understated book value, with more cash than debt, and with a number of underappreciated growth opportunities, we believe Century’s shares offer significant upside potential, along with the margin of safety we seek. With Haitzmann and Hoetzinger at the helm, this is our highest conviction name.

Most of Century’s revenues come from three countries²:

 

•		Poland (66.6% stake in Casinos Poland)			39	%
•		Canada (focused on Western Canada)			37	%
•		United States (2 properties in Colorado)			21	%

Canada will soon exceed Poland as the largest revenue contributor with construction underway on Century Mile, a racino (horseracing track and casino) located on Edmonton Airport land. This project is on target to open in the first quarter of 2019, and should surpass the hugely successful Century Downs, a racino opened in Calgary in 2015. Century will then control 6 of 14 gaming licenses in the Edmonton and Calgary metropolitan areas, arguably owning the premier property in each.

After solid performance in 2017 (up +10.94%), Century’s stock traded down -18.29% in the first quarter despite continued strong execution. The culprit was a temporary disruption in Poland. More specifically, a government process change led to license renewal delays and forced temporary casino closures. Given its extensive experience in Poland, management is confident of success and has kept staff on payroll and maintained leases. These relicensing issues weighed on Q4 2017 results, and may continue to do so early in 2018. However, we view this as a short-term problem and believe the stock price decline has created one of our best investment opportunities in some time. After trimming our position on the prior strength, we have recently been accumulating shares again.

“We want to be invested alongside talented and properly incentivized leadership.”

Even with current operations, Century trades at a sharp discount to its peers on virtually any valuation metric. Additionally, Century Mile is expected to produce nearly $50 million in revenues and $10 million in EBITDA by 2020—and to grow from there. An $8 million project in Bath, England is slated to open this May—it will be the only casino in a city which boasts 5 million tourists per year. We also expect the company to announce an expansion into Asia sometime in the next year or two, providing even more growth potential. None of these opportunities appear to be priced into the current valuation.

In our opinion, a “bet” on Century Casinos and its leaders is far from a long shot.

PORTFOLIO COMINGS AND GOINGS

We sold Gaia, Inc. (GAIA) and TechTarget, Inc. (TTGT) after both reached full value. New names included Methode Electronics, Inc. (MEI) and AutoWeb, Inc. (AUTO). Methode is a supplier of highly-engineered electronic components, primarily to the automotive industry. AutoWeb provides lead generation services to automotive dealers throughout the United States.

“We look to identify upside potential from underappreciated opportunities and/or overlooked assets.”

As always, we appreciate the opportunity to serve you and welcome any questions or comments you might have. You can also contact us directly at [email protected].

Sincerely,

 

 

David M. Maley

Lead portfolio manager

Investment Perspectives with Portfolio Manager David Maley, on the research process for the Ariel Deep Value Strategy.

Question: Describe the research process that you follow.   Answer: We typically identify potential investment opportunities through our screening process, where we apply a variety of quantitative metrics. For example, we may look for companies trading at less than tangible book value, or near their net cash balance. Once we have identified a potential investment, we learn as much as possible about the company by reading financial statements and other reports, talking with management and other informed individuals, and building a valuation model.   Question: What are some of the key metrics you look for in a company? How do metrics vs. qualitative characteristics factor into your process (art vs. science)?   Answer: We look for four characteristics in our investments: (1) size, (2) low price-to-book ratio, (3) fortress balance sheet, and (4) strong corporate governance and high insider ownership. Our research process revolves around identifying investment opportunities that meet these four attributes. As you can see, it is a combination of qualitative and quantitative analysis.

To read the full Q&A on research with David Maley, visit arielinvestments.com.

 

David M. Maley		Kenneth E. Kuhrt, CPA
Lead portfolio manager		Portfolio manager

Composition of equity holdings (%)

		Ariel Discovery Fund†		Russell 2000 Value Index		Russell 2000 Index		S&P 500 Index
Technology		28.50		7.50		14.47		21.67
Financial services		22.75		41.33		24.86		19.99
Consumer discretionary		14.75		11.76		13.64		14.05
Producer durables		11.59		12.07		13.94		10.62
Materials & processing		5.82		5.99		7.06		3.06
Energy		5.49		6.28		3.52		5.74
Utilities		4.47		6.63		4.10		4.78
Health care		4.09		6.65		16.42		13.57
Consumer staples		0.00		1.80		2.00		6.52

†	Sector weightings are calculated based on equity holdings as a percentage of total net assets.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

Since inception

Ariel Discovery Fund–Investor Class

– 5.78

+   0.10

–   1.41

–   0.14

+   2.28

Ariel Discovery Fund–Institutional Class+

– 5.68

+   0.29

–   1.15

+   0.12

+   2.52

Russell 2000® Value Index

– 2.64

+   5.13

+   7.87

+   9.96

+ 10.17

Russell 2000® Index

– 0.08

+ 11.79

+   8.39

+ 11.47

+ 11.37

S&P 500® Index

– 0.76

+ 13.99

+ 10.78

+ 13.31

+ 12.94

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

 

Expense ratio (as of 9/30/17)1		Net		Gross
Investor Class		1.25%		1.48%
Institutional Class		1.00%		1.15%

Top ten equity holdings (% of net assets)

 

		1.		Cowen Group, Inc., Class A			5.6				6.			Safeguard Scientifics, Inc.			4.1
		2.		Century Casinos, Inc.			4.5				7.			PCTEL, Inc.			3.7
		3.		ORBCOMM, Inc.			4.5				8.			Capital Southwest Corp.			3.5
		4.		RealNetworks, Inc.			4.4				9.			U.S. Silica Holdings, Inc.			3.5
		5.		Telenav, Inc.			4.2				10.			Rosetta Stone, Inc.			3.4

Recent performance showcases the value of our disciplined investment philosophy, which over time has provided both offense and defense. Following a lengthy bull run, we experienced a reality check when markets considered risk, albeit for a short while. Our portfolios kept pace as markets rose in January and provided downside protection as they sold off throughout the rest of the quarter. Our

results through this period of heightened volatility are the outcome of a time-tested, bottom-up research process.

PORTFOLIO ROUND-UP

Consumer staples continue to be favored for their resilience and recurring revenues, as evidenced by their

high valuations. In contrast, as we have recently pointed out, we view the dominant telecom companies as the new consumer staples precisely because customers are highly unlikely to cancel their telephone service, regardless of economic conditions. And yet, telecom companies continue to trade at roughly half the multiple and twice the dividend yield of traditional consumer staples—further underscoring our view that telecoms are misunderstood by today’s investors. We still believe the decline in fixed line services is behind us but the stability and growth associated with consumption of broadband and wireless services is not priced in. We see this mismatch as offering a tremendous investment opportunity.

“Recent performance showcases the value of our disciplined investment philosophy, which over time has provided both offense and defense.”

As such, we have selectively added to our positions in the telecom sector. One of our largest positions, China Mobile Ltd., continues to improve its competitive position and market dominance. The stock has underperformed which, while disappointing, offers even more upside. The headwinds are baked in but the underlying improvements are not.

We have also capitalized on recent weakness to increase our positions in NTT DOCOMO, Inc., the largest wireless telecom company in Japan, and Nippon Telegraph & Telephone Corp., Japan’s incumbent fixed line operator. Their steady cash flows and strong balance sheets are being underestimated, which allows both companies to systematically reinvest in their business to maintain leading network quality and customer service. Not to mention, both still generate enough surplus to amply reward shareholders through dividends.

As we have noted recently, another area where good companies are being unduly penalized is healthcare, which is awash with controversy. We took advantage of recent weakness to increase our position in GlaxoSmithKline plc.

This global pharmaceutical company has a high barrier to entry vaccine business, an important respiratory franchise and a consumer health arm offering attractive long-term economics and resilient cash flows. The headwind arising from the patent expiration of its blockbuster asthma drug has been priced in, but the upside from new drug launches and a promising pipeline is not, which offers a compelling risk-reward tradeoff. While management works to put the company back on a strong earnings path, we are being paid a 5% dividend yield.

Rarely does the risk-reward of an auto company look attractive, however, Subaru Corp. proves the exception. Subaru’s vehicles are highly desirable to young, educated buyers because these reliable vehicles have an inexpensive price point, a high resale value and offer superior performance on rough terrain. Despite its small size, the company enjoys one of the lowest production costs with the highest profit margins in the industry. Given their small production, unlike larger manufacturers, the company does not have to discount excess inventory. Broad concerns about the U.S. auto cycle provided an attractive entry point into the stock for Ariel Global Fund. At the present, approximately a third of its market cap is in cash, providing a potential margin of safety.*

In Ariel Global Fund, we increased exposure to Schlumberger Ltd., the largest oil services company in the world and the industry’s technology leader. Schlumberger is the technology provider to oil companies that lack internal technical capabilities which allows for pricing power and higher margins.

“Our portfolios kept pace as markets rose in January and provided downside protection as they sold off throughout the rest of the quarter.”

For Ariel International Fund, we also invested in Tecnicas Reunidas SA, a leader in engineering, design and construction in the oil and gas industry. In 2017, unforeseen project cancellations and multiple delays from top tier

customers in the Middle East caused the stock to drop. Subsequently, Tecnicas has won some marquee projects which suggests the setbacks will prove temporary and its growth trajectory will resume. The company boasts a cost-conscious management team as well as an excellent project execution and risk management. It also offers a compelling dividend yield of 5% and has a strong net cash balance sheet.

We also took advantage of the opportunity to invest in Koninklijke Ahold Delhaize N.V., a Dutch food retailer with approximately half its business in the Benelux balanced by a large U.S. business, including stores such as Food Lion and Stop & Shop. In mid-2017, the stock price fell dramatically when Amazon’s acquisition of Whole Foods sparked fears of a major disruption in the grocery industry. We felt these fears were exaggerated as the logistics of the grocery business are fairly complex and Ahold’s expertise is important. The company’s good execution and judicious capital expenditures drive superior operating margins, prodigious free cash flow generation, and generous payouts in the form of dividends and buybacks.

“Our results through this period of heightened volatility are the outcome of a time-tested, bottom-up research process.”

In order to fund the purchases described above, we reduced select positions. Within Ariel International Fund, we trimmed our position in Daito Trust Construction Co., Ltd., one of Japan’s premier apartment construction and management companies, and exited our position in Canon Inc., the well-known Japanese manufacturer of high-end cameras, printers, and imaging systems. Both had a stellar year.

In both funds, we trimmed our position in Nokia Corp., which no longer sits amongst our top ten holdings. We continue to believe Nokia will be one of the main beneficiaries of 5G spending, however, given the change in risk-reward following infrastructure spending delays by key customers, we felt it prudent to pare back our position and keep some powder dry should the stock correct further.

In the meantime, we take comfort in Nokia’s net cash balance sheet and roughly 4% dividend yield.

While we are not a thematic manager, value does tend to cluster when there is controversy. At times, these clusters will be reflected in the portfolio through more concentrated exposures to a particular sector or country. That said, our positions result from a bottom-up research process. Our thesis on each holding is bespoke as we continue to identify idiosyncratic investment ideas around the globe.

“Our thesis on each holding is bespoke as we continue to identify idiosyncratic investment ideas around the globe.”

As always, we appreciate the opportunity to serve you and welcome any questions or comments you might have. You can also contact us directly at [email protected].

Sincerely,

 

Rupal J. Bhansali

Portfolio manager

Rupal J. Bhansali

Portfolio manager

Composition of equity holdings* (%)

		Ariel International Fund†		MSCI EAFE Index		MSCI ACWI ex-US Index
Telecommunication services		16.42		3.83		3.93
Information technology		14.01		6.57		11.71
Health care		11.59		10.17		7.71
Consumer staples		10.90		11.06		9.47
Financials		10.01		21.05		23.16
Consumer discretionary		9.58		12.61		11.36
Energy		8.54		5.31		6.71
Industrials		4.20		14.60		11.80
Utilities		3.04		3.27		2.97
Real estate		0.30		3.53		3.17
Materials		0.00		8.01		8.01

*

The sectors above are the Global Industry Classification Standard (“GICS”) sector classifications. GICS was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (“S&P”) and is licensed for use by Ariel Investments, LLC. Neither MSCI, S&P nor any third party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

Since inception

Ariel International Fund–Investor Class

+ 1.36

+   9.85

+ 4.91

+ 7.62

+ 7.42

Ariel International Fund–Institutional Class

+ 1.38

+ 10.16

+ 5.16

+ 7.85

+ 7.68

MSCI EAFE Index (net)

– 1.53

+ 14.80

+ 5.55

+ 6.50

+ 8.75

MSCI ACWI ex-US Index (net)

– 1.18

+ 16.53

+ 6.18

+ 5.89

+ 7.85

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

 

Expense ratio (as of 9/30/17)1		Net		Gross
Investor Class		1.15%		1.32%
Institutional Class		0.89%		0.95%

Top ten companies^{^} (% of net assets)

 

		1.		Deutsche Boerse AG			7.3				6.			Nintendo Co., Ltd.			4.2
		2.		GlaxoSmithKline plc			5.5				7.			Michelin (CGDE)			4.0
		3.		Koninklijke Ahold Delhaize N.V.			5.3				8.			NTT DOCOMO, Inc.			3.3
		4.		China Mobile Ltd.			5.0				9.			Gemalto N.V.			3.2
		5.		Roche Holding AG			5.0				10.			Telefonica Deutschland Holding			3.2

 

^	For the purposes of determining the Fund’s top ten, securities of the same issuer are aggregated.

Top ten country weightings^† (% of net assets)

 

Japan		18.07		China		7.83
Germany		11.31		France		5.94
United Kingdom		8.84		United States		5.40
Switzerland		8.64		Spain		3.37
Netherlands		8.51		Italy		3.05

Rupal J. Bhansali

Portfolio manager

Composition of equity holdings* (%)

		Ariel Global Fund†		MSCI ACWI Index
Health care		20.98		10.65
Information technology		19.42		18.80
Financials		13.08		18.68
Telecommunication services		12.87		2.89
Consumer staples		7.77		8.41
Energy		7.22		6.20
Consumer discretionary		5.41		12.27
Industrials		4.07		10.86
Utilities		3.98		2.89
Materials		0.00		5.36
Real estate		0.00		2.99

*

The sectors above are the Global Industry Classification Standard (“GICS”) sector classifications. GICS was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (“S&P”) and is licensed for use by Ariel Investments, LLC. Neither MSCI, S&P nor any third party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

Average annual total returns (%) as of 03/31/18

Quarter

1-year

3-year

5-year

Since inception

Ariel Global Fund–Investor Class

+ 0.26

+   9.58

+ 5.97

+ 8.81

+   9.25

Ariel Global Fund–Institutional Class

+ 0.33

+   9.82

+ 6.22

+ 9.09

+   9.53

MSCI ACWI Index (net)

– 0.96

+ 14.85

+ 8.12

+ 9.20

+ 11.00

Performance data quoted represents past performance and does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains. 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. To access performance data current to the most recent month-end, visit arielinvestments.com. The minimum initial investment for Investor Class shares is $1,000; the minimum for Institutional Class shares is $1,000,000.

Growth of a $10,000 investment since inception (Investor Class)

 

 

Expense ratio (as of 9/30/17)1		Net		Gross
Investor Class		1.15%		1.42%
Institutional Class		0.90%		1.01%

Top ten companies^{^} (% of net assets)

 

		1.		Microsoft Corp.			8.6				6.			Baidu, Inc.			4.7
		2.		GlaxoSmithKline plc			5.6				7.			Johnson & Johnson			3.9
		3.		Gilead Sciences, Inc.			5.4				8.			Deutsche Boerse AG			3.7
		4.		China Mobile Ltd.			5.1				9.			Berkshire Hathaway Inc., Class B			3.4
		5.		Roche Holding AG			5.0				10.			Michelin (CGDE)			3.2

 

^	For the purposes of determining the Fund’s top ten, securities of the same issuer are aggregated.

Top ten country weightings^† (% of net assets)

 

United States		43.04		Germany		4.85
China		9.76		France		4.51
Japan		9.13		Netherlands		3.65
United Kingdom		6.81		Finland		2.58
Switzerland		5.83		Italy		1.02

Headquartered in Santa Rosa, CA, Keysight Technologies is a leading electronic test and measurement company. The company’s history dates back to 1939 as the original business of Hewlett Packard. Its first instrument, an audio oscillator, was used to test sound equipment for Disney Studios. Over time, Hewlett Packard moved into computing technology and this legacy business was spun off multiple times. As a standalone business today, Keysight’s products are used by communications and electronics engineers to measure electronic signals, helping them develop and manufacture cutting edge technologies faster and at a lower cost.

FUELING ITS OWN FIRE

For most of its history, Keysight was constrained by its role as the cash cow for other businesses. In the 1960s, its cash flows helped Hewlett Packard blaze the trail into enterprise and personal computing. Later as a part of Agilent Technologies, it funded the expansion into life sciences-related opportunities. Now, Keysight can for the first time devote all of its resources towards accelerating its own growth. Since the spin-off in 2014, the company has improved organizational efficiency, increased investment in research and development and strengthened its product portfolio. This is no longer the business founded nearly 80 years ago in a one-car garage in Palo Alto. Today’s Keysight is targeting mid-single digit revenue growth, low-twenties operating margins and double-digit earnings per share growth.

READY FOR 5G, AND BEYOND

With over 60% of the business tied to the communications industry, Keysight’s positioning for 5G wireless technology is the key focus of investors today. The company has been leveraging its long history and deeply rooted relationships to gain a seat at the table as standards are being set, giving it an

early advantage as 5G is tested and deployed in the coming years. Last year, it was first to market with several design solutions, generating over $100M in orders. Yet, that is only part of the story. We see several other underappreciated tailwinds to fuel growth, including artificial intelligence, Internet of Things, autonomous vehicles, virtual reality and even advancements in electronic warfare.

COUNTING THE CASH

Now that over three years have passed since the spin-off, Keysight has started to return its attractive free cash flows to shareholders. Until recently, the focus had been on increasing internal investment in research and development and acquiring companies to help accelerate the growth profile of the business. With that phase complete, capital allocation has shifted to paying down debt and buying back shares. By the end of this fiscal year, Keysight expects free cash flow conversion to be over 80%, gross leverage to be just 2.0x and the bulk of free cash flow to be directed towards a new $350 million share repurchase program.

A LONG TERM VIEW

At current levels, investors remain both anchored in the historical growth profile of the old Keysight, while also impatient for the tailwinds from future technologies. As long term investors, we see a rare example of an excellent, competitively advantaged franchise that stands to benefit from several nascent technological mega trends. Since our initial purchase nearly a year and half ago, Keysight has consistently exceeded investors’ expectations, another trend that we believe is still only in the early innings. As of March 29, 2018, shares traded at $52.39, a 10.5% discount to our private market value of $58.52.

Founded in 1878, Mohawk Industries is the world’s leading manufacturer and distributor of floorcovering products. The company markets to both residential and commercial customers competing in all major flooring categories including carpet, hardwood, laminate, vinyl and ceramic tile. Some of the most recognizable brands include names such as Mohawk, Pergo, Karastan, Daltile, Quick-Step, and American Olean.

COVERING THE WORLD ONE STEP AT A TIME

When we initiated our position in Mohawk, the company was the leading manufacturer of carpet in the United States. Through several acquisitions, floorcovering product portfolio growth, and geographic market expansion, the company has become the world’s leading manufacturer of floorcovering. Mohawk now serves over 25,000 customers in 170 countries with manufacturing facilities in 17 countries. With significant insider ownership by a tenured, superior management team, Mohawk has blossomed into a large, highly-respected organization within the building supply sector.

INDUSTRY CONTINUES TO REBOUND

Following the Great Recession, the U.S. floorcovering industry declined a devastating 38%. After hitting bottom in the U.S. in 2011, the industry is now in the seventh year of a rebound. Despite this recovery, floorcovering still remains 12% off its 2005 peak. In our view, the industry’s growth can be propelled by a number of tailwinds: continuing economic expansion as unemployment and mortgage rates remain low; solid GDP growth; and a growing number of first time home buyers. Historically, these forces drive new home construction and home sales, thereby, driving

floorcovering growth. In addition to residential growth opportunities, the commercial marketplace accounts for 26% of the U.S. floorcovering market. Historically, as companies find it difficult to attract and retain employees in low unemployment environments, managements use upgraded office space as an attractive option. Businesses are sitting on substantial amounts of cash fueled by worldwide economic growth and tax reform within the United States, which should allow for continued office upgrades. We think the combined effect of these positive factors should translate into continued solid revenue growth for Mohawk.

SHORT-TERM PAIN FOR LONG-TERM GAIN

Unfortunately, during the first-quarter 2018 Mohawk’s shares underperformed for several reasons. First, concerns over inflation and raw material price increases grew. Historically, the industry has raised prices to offset increased costs. Second, the company surprised Wall Street when it announced a heavy internal expenditure year for 2018. Mohawk will be investing to meet the increased demand in sales capacity growth. Over the years, this management team has proven to be smart capital allocators. They have remained disciplined in a fast consolidating industry and stayed focused on paying down debt. As a result, Mohawk boasts a strong balance sheet that is well positioned for long-term growth. We believe raw material costs and targeted investments may cause some short-term pain but will ultimately lead to higher long-term profitability.

As of March 29, 2018, shares traded at a 20% discount to our PMV of $291, we believe Wall Street does not fully appreciate the underlying cost savings potential from increased automation and acquisition synergies the company will exhibit as volumes continue to rise.

Oaktree Capital Group is a leading global alternative investment management firm with expertise in credit strategies including distressed debt and high-yield bonds. Formed in 1995 by a group including Howard Marks and five other partners from what is now named The TCW Group, Oaktree reported $100.2 billion in assets under management as of year-end.

A LEADING GLOBAL ALTERNATIVE FRANCHISE

Oaktree Capital Group is one of the largest and most successful firms in alternative investment management. The company is one of only a handful of firms that has the size and organizational structure to benefit from the continued high level of institutional interest in alternative assets. Oaktree’s competitive advantages include its global platform, experienced investment professionals, and unifying investment philosophy. The Company’s 35 portfolio managers average 23 years at Oaktree and over 813 years of combined industry experience.

MANAGING THROUGH VOLATILITY

Alternative investment management firms have had favorable economics. The industry has relied on long-term capital to create a stable base of recurring revenues and earnings to generate high levels of return on equity. Oaktree possesses an impressive track record and culture. In contrast to most private equity firms, Oaktree’s focus on distressed investments makes its business somewhat countercyclical.

TAX REFORM OPPORTUNITY

Most publicly-traded alternative asset management firms are structured as publicly-traded partnerships. As such, they

avoid most corporate level tax and do not pay corporate tax on capital gains from the sale of their holdings. In contrast, publicly-traded companies are taxed at the corporate rate. Many investors will not invest in publicly-traded partnerships for a variety of reasons including potentially complex tax reporting. That said, with the recent U.S. corporate tax rate change to 21% from 35%, many firms are performing cost-benefit analyses to determine the structure best suited for their businesses. We would not be surprised if Oaktree concluded that it would be advantageous to pay the corporate tax and become a publicly-traded company. We would argue that new shareholders, along with a high probability of inclusion in the major indexes, could lead to a higher public valuation and subsequent higher share price.

INTRINSIC VALUE GREATER THAN SUM OF THE PARTS

In our view, Oaktree’s fundamentals remain solid given attractive secular trends, its strong track record and fundraising momentum. We acknowledge there is little consensus on how to value alternative asset managers. Economic Net Income is volatile and difficult to predict because of mark-to-market gains and losses. Cash carry is also difficult to forecast quarter to quarter. At its current valuation, however, we believe the market is significantly underestimating Oaktree’s structural advantage of having a lengthy lock-up period to implement its strategy, the sustainability of its performance fees, its DoubleLine Capital equity stake, and the countercyclical nature of its business model. Using our “sum of the parts” analysis, we arrive at a private market value of $63. With a March 29, 2018 closing price of $39.60, Oaktree traded at a 37% discount to our private market value and at a P/E multiple of 11.2x.