Q: There has been much talk of a hard-landing scenario given the Fed’s aggressive rate hikes and quantitative tightening of its balance sheet. We also saw a mini bank crisis.

Melody Hobson: I would say that the banking situation is obviously unstable. But again, just like John says, I think everything is being done to make sure that it doesn’t spiral and that we don’t have a domino effect.

SVB and First Republic and Signature and some of the other things that we’ve seen are not sitting around with regulators, and these latter banks are much smaller, they have much less industry concentration. It’s not nearly the same scenario.

SVB was significant because it was the 16th largest bank in America.

Q: How have you taken advantage of the explosion in capital markets in terms of Silicon Valley Bank? We saw a really wicked sell off. Are you buying or selling?

John W. Rogers: We’re looking for new ideas and adding to our favorite ideas.

So anything that has any cyclicality has had a really hard time. Anything that has anything to do with the housing market has had a tough time. So we leaned into that area, buying more of our favorite names. So like in the housing area, a company like Mohawk that makes carpeting is an incredibly cheap stock for us.

We are adding to private equity firms like Carlyle. We added Oklahoma Bank taking advantage of the displacement we saw in the financial services sector of the market.

And then in some of our light cycles, we’re adding there and finding opportunities in companies like Residio (a Honeywell spinoff that provides home automation solutions, like smart thermostats). This kind of light cycle we think is very cheap in this environment.

Q: How do ESG considerations fit into Ariel’s bottom-up, long-term investment style? Are these considerations important or not and why?

Melody Hobson: I’ll start and I’ll say that these considerations are important and always have been. ESG has become much more popular of late, but if you go back to the inception of our flagship mutual fund Ariel Fund, you will find that we have had these ESG considerations in the fund since its inception, and we have further integrated ESG into our investment process over the years. . We have a dedicated ESG team on the domestic equity side, on the international global side — ESG is deeply involved in every analyst’s research because we think there is a direct correlation between these issues and financial returns. It’s not a marketing ploy or a headline that we think works. We want to reduce risk in our portfolio, and considering these ESG factors can be detrimental to the long-term value creation of businesses, we think we’re doing just that.

John W. Rogers: I would just add to the fact that when we started our mutual fund, as Melody said, in 1986, we were known as a socially responsible fund company.

You know, you didn’t have the ESG terminology back then. But since the beginning, we’ve been concerned about the environment, concerned about handguns, concerned about governance, concerned about D&I. All those things were very important and today, looking forward 36, 37 years later, they are just as, if not more, important.

We have a great team that makes sure we’re evaluating every company for its ESG score and helping companies get to where they need to be. We focus on small- and medium-sized companies and they can really benefit from our advice and our expertise in this field.

We’ve told companies that if you run yourself like a 1940s company, with no concern for the environment, no concern for diversity, no modern governance practices, we can’t invest in you, it won’t work for us.

Q: So you blame these companies? Did you really do your due diligence and did you check in with them?

John W. Rogers: We check in with them regularly. We do our due diligence. And we’re 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 Tokes (Deputy Dean of Faculty, Professor of Finance, Yale School of Management) is an expert in the ESG area. Martijn Kremers, (Martin J. Gillen Dean, Bernard J. Hank Professor of Finance at the University of Notre Dame’s Mendoza College of Business) helps lead all of our thoughts. And John Oxtoby (Ariel’s senior vice president, director of ESG investments) actually teaches a course at the Harris School for the University of Chicago.

We want to stay ahead of the curve on everything we do, so we can point to the difference we’re making. So as an example around D&I, we can point to the fact that over the years we’ve been able to get a company their first diverse board member, more than 55 times. And because we push them and push them and talk to them about the importance of having different perspectives in the boardroom, we’re able to make a difference.

Q: What do people get wrong about ESG? What are people missing about ESG stories?

Melody Hobson: I’ll start by saying that I think the politicization of ESG in America is extremely dangerous. That’s the wrong direction, and it has implications that I don’t think we understand yet.

I would advise anyone who is thinking about this issue and turning it into a political issue to think twice, because again, we are thinking too much about the long-term shareholder value in these companies that is created or destroyed by a lack of focus. Very important and relevant ESG issues.

I think one of the mistakes that people make is to think that you compromise on returns, that somehow you get less income by focusing on these things. We think it’s just the opposite. You get higher returns by paying attention to these things and ultimately, as I suggested, really understanding the risks that companies are taking and the risks that you’re taking by investing in those companies, and our goal as investors is to minimize risk.

Q: Let’s talk about long-term value investing, which is your bread and butter. Value investors have had a really rough few years.

Melody Hobson: A Decade.

Q: I was trying to be polite! It was about FAANG, Facebook, Tesla, you name it. Now that we’re seeing some of that luster fade, why is value investing trending now?

John W. Rogers: I think value investing is in vogue now because growth has been such a strong decade.

Everyone believed that those stocks would just go up and up. That they were not tied to any kind of normal evaluation metrics. That’s what happens in trends. The same happens with bubbles.

And so you never know exactly when you’re nearing the end of a market cycle that’s going too far. But when they burst, they burst dramatically and then create opportunities for sectors that are not favorable to finally have their day in the sun. And I think that’s what happened. Those stocks became very expensive, the FAANG stocks, people were buying them as one-off stocks like they did in the 70s when your growth stocks were selling at extraordinary multiples, or during the Internet bubble, when tech stocks were booming. These things always end up in a bad way. And eventually the price returns. Unfortunately, sometimes you have to live through the pain to be able to take advantage of those bargain buying opportunities.

Q: There are many great value-related companies, but they have been so neglected in the last decade. They have become so cheap that you really have to say to yourself, this is like a candy store.

Melody Hobson: Of course, but the environment has also changed. It was a perfect environment for growth. So in the last decade, with money essentially free, it really becomes the life blood of a growth stock.

Once rates started to rise it was clear that they would rise. And one thing we’ve written many, many times, is that you can be a great company and not a great stock. Many of these companies are great companies, great businesses, but their valuations are higher than what was possible. And they were priced for perfection.

And perfection did not consider the increase in interest rates. So now we’re in a very different environment and we think that environment gives value to investors.

The pendulum has swung so far that if you only believe in mean reversion, not even the unrealized value in some value stocks, you’re going to see better times for value.

And if you look historically at the last 70, 80, 90, a hundred years, and you look at price versus growth in those decades, this last decade was an outlier. It was actually a period of 12 years. And so when we look at that, we, as natural contrarians, we see huge opportunities, not to mention the valuations that are there.

And again, if you add another condition that suited them, which was the Covid scenario, when we were all confined to our homes. It was perfect for those companies, Amazon, Microsoft, Netflix, etc. Being in our homes and being technologically connected has become a very big and important deal.

Q: Speaking of Covid, what surprises you the most about financial markets?

John W. Rogers: What was surprising was how quickly we adapted. You couldn’t go to your office. You weren’t supposed to be out on the streets. It was such a scary time, but so quickly people adjusted. They learned to operate through zoom and suddenly the market, as it always does, began to look to the future and what it would look like when things returned to normal. And so we had that serious drop. You know, we went into such a quick recession, but I think we came out a lot faster than anyone would have expected. So that’s another lesson – the fact that trying to be a market timer doesn’t work.

If you try to time it, you’ll never get it right. Staying in the market for the long term and taking advantage of bargains can benefit you. Volatility should be your friend and not the problem.

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