Ariel Investments Director of Research for International & Global Equities Chaim Schneider discusses the research process for the Ariel Global Strategy. Read the full Q&A below.
Investments in foreign securities may underperform and may be more volatile than comparable U.S. stocks because of the risks involving foreign economies and markets, foreign political systems, foreign regulatory standards, foreign currencies and taxes. The use of currency derivatives and exchange-traded funds (ETFs) may increase investment losses and expenses and create more volatility. Investments in emerging markets present additional risks, such as difficulties in selling on a timely basis and at an acceptable price. The intrinsic value of the stocks in which we invest may never be recognized by the broader market. Attempting to purchase with a margin of safety on price cannot protect investors from the volatility associated with stocks, incorrect assumptions or estimations on our part, declining fundamentals or external forces.
Question: Describe the research process that you follow.
Answer: Our research process is designed to find franchise-quality companies that are misunderstood and therefore mispriced by the market. We dig deeply into a company’s business model using 360-degree fundamental research in order to identify the best-in-class companies whose prospects can decouple from their industries, and then peel the onion to try to understand the source and sustainability of each company’s competitive advantage. Because we also pay close attention to risk management, we proactively assess not just the upside potential of an investment idea if things go right, but also the downside risks if things go wrong.
Question: As you begin to research an investment, what do you hope to learn? What is top of mind for you?
Answer: When we start researching a company, we try to eliminate them from consideration as a means of avoiding businesses that come with risks that are too high to bear, including factors such as weak balance sheets, poor corporate governance, or low returns on invested capital relative to their weighted average cost of capital.
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 use both quantitative and qualitative characteristics as part of our process. Quantitative metrics can include return on invested capital relative to weighted average and fixed charge coverage ratios, and our qualitative evaluation can include proprietary analyses of business model risk, which may incorporate assessments of risk factors such as product or customer concentrations.
Question: Do macro-economic factors affect your investment process? For example, do rising interest rates play into your thought process?
Answer: As global investors, we consider both macro and micro variables in our analysis, including the effects of currency or interest rates. That said, our investment decisions are driven primarily by our bottom-up analysis of the company’s long-term business prospects.
Question: What will immediately make you eliminate a company from consideration?
Answer: Companies run by management teams who consistently make poor capital allocation decisions.
Question: Since you often buy stocks when they’re under a cloud, how do you distinguish between a great bargain versus a potential mistake?
Answer: Our investment discipline seeks to buy quality when it’s on sale, not junk at clearance prices. We only consider investing in businesses that have solid long term fundamental prospects, and we wait patiently to buy them when they are priced with a margin of safety. In this way, we can identify great bargains while generally avoiding value traps.
Question: How would you distinguish Ariel’s research process from other investment firms? What makes Ariel’s research process different?
Answer: We invest to our convictions, not to benchmarks. This means that we are willing to own stocks, sectors, and geographies that other investors may avoid. Our patient investment approach allows us to take advantage of short term volatility.
Question: Is there a beginning or an end to the research process?
Answer: No. Research is a continuum. The world is constantly changing. Change provides opportunity. As active managers, we are constantly on the lookout for these opportunities.
*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.