Ariel Investments Portfolio Manager David Maley answered questions about active portfolio management. David is the Portfolio Manager for the following Deep Value Strategies: Ariel Micro-Cap Value and Ariel Small Cap Deep Value. Read the full Q&A below.
Investing in small/micro-cap stocks is more risky and volatile than investing in large-cap stocks. The intrinsic value of the stocks in which we invest may never be recognized by the broader market.
Question: How do you add value with active management?
Answer: In my part of the world, it’s very simple. The small cap segment of the market is truly inefficient in the short, and sometimes, even intermediate term. As such, I think that that there is no argument that this part of the market cries out for active investment.
I think the most important thing to know about our deep value strategies is that they are very long-term. Small, low-priced-to-book investing has lots of academic research that shows that it works. It’s a part of the market where there are inefficiencies that we can take advantage of. If you invest with us, you can be sure that we won’t waver from our strategy, even though at times it may be out of favor. Each product will be very small in terms of the market cap of our stocks. We will have a portfolio that predominantly has very good balance sheets and that trades as a low price-to-book, or price-to-net-asset ratio relative to the rest of the market.
Question: As an active manager what makes your deep value products different?
Answer: We have a very disciplined approach in that we only want to buy when we think we have a true margin of safety*, but we’re flexible in the metrics that we apply. We try to ask ourselves, “What is the right way to value this company now? And what might be the right way to value it in the future if the situation changes?” For instance, sometimes we’ll buy a company because it’s cheap on its current assets. Other times, we’ll buy it because it’s cheap on other assets— maybe hidden assets. And other times, we’ll buy a company because we believe it’s cheap on its earnings. Many other value investors will apply only one of those lenses and say, “I only buy low price-to-book. I only buy low P/E (price/earnings). I only buy low on EV (enterprise value) to EBITDA (earnings before interest, tax, depreciation and amortization).” We believe that every company has a different method that’s the right way to value it, and we try to assess that.
Also, most other microcap or very small cap asset-based approach products tend to own more stocks than we will. We’ll typically own thirty-five to forty stocks. As high conviction investors, we try to get to know our companies very well, and we want to own stocks that we know the best and feel most strongly about (this is an idea that Warren Buffett has always talked about). We feel that with forty stocks, we have reasonable diversification, but we choose to own our forty best ideas. We don’t want to own the next forty best, because we think they’re not as attractive, and therefore, may have more risk.
Question: Can you talk more about risk?
Answer: We view risk as the likelihood of permanent impairment of capital. I don’t think of risk as volatility or standard deviation. Risk is not a statistic. It’s the risk of being wrong.
I think there’s a misconception that our part of the market, the very small end of the market, is necessarily very risky. Certainly, there are risky companies and risky stocks in the microcap part of the world. However, we try to screen out that risk by looking for companies with great balance sheets. We feel that when we buy these stocks at discounts to their asset value, when they have great balance sheets, we’re actually taking a great deal of the risk out of the equation. And so, I think what we do is much lower risk than many investors expect.
*Attempting to purchase within a margin of safety on price cannot protect investors from the volatility associated with stocks, incorrect assumptions or estimates on our part, declining fundamentals, nor external forces. Investing involves risk.
Past performance does not guarantee future results. Investing in equity stocks is risky and subject to the volatility of the markets. Investing in small/micro-cap stocks is more risky and volatile than investing in large-cap stocks. The intrinsic value of the stocks in which we invest may never be recognized by the broader market.
Mr. Maley candidly discusses his viewpoints of market conditions and historic overview. The information contained herein is not guaranteed as to its accuracy or completeness. It should not be considered investment advice. The opinions expressed are current as of March 1, 2018, but are subject to change. The information provided herein 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 stock or fund. It also is not meant to be individualized retirement planning or investment advice. Consult your financial professional for advice suited specifically to your individual needs. Consult your financial professional and/or tax advisor for advice suited specifically to your individual needs.
by David Maley: