Q: There's just been a lot of talk about a hard-landing scenario because of the Fed's aggressive rate hikes and the quantitative tightening of its balance sheet. We've also seen a mini bank crisis.
Mellody Hobson: I would say that the banking situation is obviously one that is unsettled. But again, just like John is saying, I think everything is being done to make sure that this does not spiral and that we don't have a domino effect.
There's not been any sitting on the hands by the regulators around the issues with SVB and First Republic and Signature and some of the other ones that we've seen, and this next group of banks behind are just much smaller, they have much less industry concentration. It's not nearly the same kind of scenario.
SVB was significant because it was the 16th-largest bank in America.
Q: How have you taken advantage of the eruptions in capital markets in the wake of Silicon Valley Bank? We did see a really vicious sell-off. What have you been buying or selling?
John W. Rogers: We've been looking for new ideas and adding to our favorite ideas.
So anything that has any cyclicality to it has had a really tough time. Anything that has any ties to the housing market has had a very difficult time. So we've been leaning in those areas, buying more of our favorite names. So like in the housing area, a company like Mohawk that makes carpeting is an extraordinarily cheap stock to us.
We've been adding to private equity firms, like Carlyle. We've added to the Bank of Oklahoma, taking advantage of the dislocation that we've seen in the financial services sector of the marketplace.
And then in some of our light cyclicals, we've also been adding there and finding opportunities in companies like Resideo (a Honeywell spinoff that offers home automation solutions, such as smart thermostats). Those kind of light cyclicals we think are very cheap in this environment.
Q: How do ESG considerations fit into Ariel's bottom-up, long-term style of investing? Are those considerations important or not and why?
Mellody Hobson: I'll start and I'd say those considerations are important and always have been. ESG has become much more popular of late, but if you go back to the founding of the Ariel Fund, our flagship mutual fund, you will see we have these ESG considerations in the fund from its inception, and we've further integrated ESG into our investment process as the years have gone on. We have a dedicated ESG team on the domestic equity side, on the international global side — ESG is deeply steeped into each analyst's research because we do think there's a direct correlation between these issues and financial returns. This is not a marketing gimmick or a headline that we think works. We want to mitigate risk in our portfolios, and by considering these ESG factors that could be detrimental to the long-term value creation of the business, we think we're doing just that.
John W. Rogers: I would just add to the fact that when we started our mutual funds, as Mellody said, in 1986, we were known as a socially responsible fund company.
You know, you didn't have the terminology ESG back then. But from the very beginning, we'd been concerned about the environment, concerned about handguns, concerned about governance, concerned about D&I. All those things have been very important and today, looking ahead 36, 37 years later, they're just as, if not more, important.
We have a great team of people making sure that we are evaluating each and every company for its ESG score and helping companies get to where they need to be. We focus on small- and mid-sized companies and they can really benefit from our counsel and our expertise in this area.
We've told companies we can't invest in you if you are running yourself like a 1940s company, with no concerns for the environment, no concerns for diversity, not having modern governance practices, that's just not going to work for us.
Q: So you do hold these companies accountable? You really do your due diligence and you check in with them?
John W. Rogers: We check in with them regularly. We do our due diligence. And we stay on top of all the thought leadership in this area, you know, which is really important.
We have two academics on our board of directors. Heather Tookes (deputy dean of faculty, professor of finance, Yale School of Management) is an expert in ESG areas. Martijn Cremers, (Martin J. Gillen dean, Bernard J. Hank professor of finance at the University of Notre Dame's Mendoza College of Business) helps with all of our thought leadership. And John Oxtoby (Ariel's senior vice president, director of ESG investing) actually teaches a course at the Harris School for the University of Chicago.
We want to stay ahead of the curve on everything that we do, then we can point to the difference we've been making. So one example around D&I, we can point to the fact that over the years we've been able to get, over 55 times, a company to have their first diverse board member. And because we push them and nudge them and talk to them about the importance of having diverse perspectives in the boardroom, we're able to make a difference.
Q: What do people get wrong about ESG? What are people missing about the ESG story?
Mellody Hobson: I'll start this off by saying I think the politicization of ESG in America is extremely dangerous. It's the wrong direction, and it has implications that I think we don't even understand yet.
I would counsel anyone who's thinking about that issue and making it a political issue to really think twice, because again, we're thinking very much about the long-term shareholder value that is created in these companies or destroyed because of a lack of attention to very important and relevant ESG issues.
One of the things I think that people do get wrong is to think that there's some kind of compromise you make in returns, that somehow you get lower returns by paying attention to these issues. We think it's just the exact opposite. You get higher returns by paying attention to these issues and ultimately, as I suggested, really understanding the risks that the companies are taking and that you're taking by investing in those companies, and our goal as investors is to mitigate risk.
Q: Let's talk about long-term value investing, which is your bread and butter. Value investors have had a really rough several years.
Mellody Hobson: A decade.
Q: I was trying to be polite! It was all about the FAANGs, Facebook, Tesla, you name it. Now that we are seeing some of that luster go away, why is value investing in vogue now?
John W. Rogers: I think value investing is in vogue now precisely because growth had such a strong decade.
Everyone just believed those stocks would just go up and go up. That they were not tied to any kind of normal valuation metrics. That's what happens in trends. That's what happens in bubbles.
And so you never know exactly when you're at the end of a market cycle of things going just too far. But when they burst, they burst dramatically and then create opportunities for those sectors that have been out of favor to finally have their day in the sun. And I think that's what's happened. Those stocks just got to be too expensive, the FAANG stocks, people were buying them as one-decision stocks the way they did in the '70s when you had growth stocks selling at extraordinary multiples, or during the internet bubble, when technology stocks were booming. Those things always come to a bad end, and ultimately value comes back. Unfortunately, sometimes you have to live through the pain to be able to benefit from being able to take advantage of those opportunities to buy bargains.
Q: There's a lot of great value-related companies, but they were so overlooked in the last decade. They've become so cheap to the point where you have to really say to yourself, this is like a candy store.
Mellody Hobson: Sure, but also the environment has changed. It was the perfect environment for growth. So the last decade, with money basically being free, that really becomes just the lifeblood of a growth stock.
Once rates started to rise it was apparent they would have their comeuppance. And one of the things we've written about many, many times, is that you could be a great company and not a great stock. Many of those companies are great companies, great businesses, but their valuations just overshot what was possible. And they were priced for perfection.
And perfection did not consider interest rates going up. So now we're in a much different environment and we think that environment favors value investors.
The pendulum swung so far that if you just believe in mean reversion, not even the value that is unrecognized in some of the value stocks, you are going to see a better time for value.
And if you looked historically at the last 70, 80, 90, a hundred years, and you look at value vs. growth, over those decades, this last decade was an outlier. It was actually a 12-year period. And so when we look at that, we, as natural contrarians, we see huge opportunity, not to mention the valuations that are there.
And again, if you add in one other condition that was perfect for them, which was the COVID scenario, when we were all locked in our homes. It was perfect for those companies, Amazon, Microsoft, Netflix, et cetera. Being in our houses and being connected technologically became a very big and important deal.
Q: Speaking of COVID, what surprised you the most about the financial markets?
John W. Rogers: The surprise was how quickly we adapted. You couldn't go to your offices. You weren't supposed to be out in the streets. It was such a scary time, but so quickly people adjusted. They learned to work through Zoom and all of a sudden the market, as it always does, starts to look to the future and see what it's going to look like when things get back to normal. And so we had that severe drop. You know, we went into that kind of quick recession, but came bounding out so much more rapidly than I think anyone could have anticipated. So it's just another lesson — the fact that trying to be a market timer just doesn't work.
If you tried to time that, you would've never gotten it right. By being in the markets over the long term and taking advantage of the bargains that came about, you can benefit. Volatility should be your friend and not a problem.