Hot markets have been test of patience for Ariel’s Rogers

By Steven R. Strahler

CHICAGO — Strange as it seems, John Rogers is pining for a market correction.

Mr. Rogers is founder, chief executive officer and chief investment officer of Ariel Capital Management LLC. The Chicago firm's total assets under management dropped more than 20% to $16.8 billion for the year ended June 30, the biggest decline in more than 10 years.

Some investors antsy for better returns are ditching the firm.

The $36.8 billion Illinois Teachers' Retirement System, Springfield, pulled its $452 million portfolio in May. Ariel also was dropped by the $1.5 billion Milwaukee County Employees' Retirement System. Others — including the $11.2 billion Illinois State Board of Investment, Chicago, which has $166 million with Ariel — are reviewing their relationships with the firm.

Mr. Rogers blames the three-year market expansion that has lifted indexes such as the Standard & Poor's 500 by more than 10% per annum.

"We would like to see hot markets cool," said Mr. Rogers in an interview. "The last three years, the wind has not been at our back. The steady-Eddie, quality-type companies have done terrible."

Ariel isn't the only value manager to struggle during the recent bull market. And its size and long-term track record give Mr. Rogers time to turn things around.

But it's clear his patience is wearing thin. He said he'll call for action at a couple of the more troubled companies in Ariel's portfolio — a radical switch for the company whose slogan is "slow and steady wins the race."

Behind the urgency is a 13% drop in Ariel's assets during the three months ended June 30, when major holdings such as Career Education Corp. and Hewitt Associates Inc. tanked and commodity stocks Ariel didn't own were on a tear.

"Staying out of the oil business has crushed them over the last year to 18 months," said Jack Walsh, investment officer for the $2.4 billion City of Cincinnati Retirement System, which in March put its $100 million Ariel portfolio on watch for underperformance.

Ariel has also been hurt by its policy of concentrating holdings in relatively few stocks, with a bias toward local companies. For instance, looking at the firm's two largest mutual funds — the $4.25 billion Ariel Fund and the $2.66 billion Ariel Appreciation Fund — just three of 14 Chicago issues account for 16.8% of the market value of one fund, while two Chicago stocks contribute to 11.8% of the other.

Terming this a home-court advantage, Mr. Rogers said it has paid off over time.

But in the 12 months ended Aug. 31, Ariel's biggest local holdings suffered a net decline. Tribune Co. is down 12%; Career Education Corp. fell 51%; Jones Lang LaSalle Inc. rose 71%; Hewitt Associates Inc. dropped 23%, and ServiceMaster Co., 12%.

Mr. Rogers won't say where he plans to press for change, but Ariel officials have called for shakeups at Hewitt and ServiceMaster.

Last week, Mr. Rogers and Ariel portfolio managers met and targeted five or six companies for possible action. This fall, Ariel is likely to publicly call for a sale or other "strategic alternatives" at two of the targets, he said.

One is believed to be H&R Block Inc., the Kansas City, Mo.-based tax preparer that branched into mortgage and other financial services, only to encounter red ink. Ariel, the company's fourth-largest shareholder, began buying shares in early 2005 and added 3.8 million shares not long before Block announced in August its biggest quarterly loss in years.

A Block spokesman said, "We remain steadfast in our approach to operating all of our businesses to create long-term value for shareholders."

To blunt further investor defections, Mr. Rogers needs to show he's got a handle on problems. The State Board of Investment is expected to review the status of its Ariel portfolio at a meeting Sept. 22.

"The tough call investors have to make is, can Ariel recover from the underperformance relative to the benchmarks over the last three years?" says Executive Director William Atwood. "Right now, it's not looking so good."

But Mr. Rogers points out Ariel has survived rough stretches before — as it did when the Illinois Teachers fund defected in 1994, only to return in 2001 when Ariel was in the midst of quadrupling its assets. "We've shown people we can bounce back from those periods very confidently."

Steven R. Strahler is a reporter with Crain's Chicago Business, a sister publication of Pensions & Investments.