REPRINTED WITH PERMISSION

April 17, 2023

Cover Story:
Ariel co-CEOs use Buffett-style investing model

John Rogers, Mellody Hobson say time is right for value focus

John W. Rogers Jr. and Mellody Hobson, who share the co-CEO title at Ariel Investments, one of the most influential minority-owned global asset management firms, sat down in early April for their first joint Face to Face interview with Pensions & Investments in Chicago, against the backdrop of the Silicon Valley Bank collapse and another dose of Federal Reserve rate hikes.

Mr. Rogers and Ms. Hobson discussed Ariel’s active patience approach to value investing in out-of-favor small and midcap companies as well as Ariel’s long-term business and societal philosophy, which spark comparisons to another famous partnership: Warren Buffett and Charlie Munger.

Mr. Rogers, who founded Chicago-based Ariel in 1983 when he was 24 and also serves as chairman and CIO, and Ms. Hobson, who also holds the title of president, have followed the “Warren Buffett value investing” strategy since Ariel’s inception 40 years ago.

As the end of December, Ariel managed $16.2 billion.

The investment firm’s slow and steady strategy has yielded an annualized 9.39% return in the institutional share class of its flagship Ariel Fund over the 10 years ending March 31, outperforming the Russell 2500 Value index and the Russell 2500 index. Since inception, the Ariel Fund has outperformed both Russell indexes as well as the S&P 500 index.

Ariel’s long-term business and societal philosophy has also translated into opportunities for underrepresented communities. Ariel’s affiliate, Ariel Alternatives, in February closed its private equity fund Project Black with $1.45 billion of commitments. The fund seeks to invest in middle-market companies that may not currently be minority-owned, as well as existing Black- or Latino/Latina-owned businesses, with $100 million to $1 billion in revenue.

Questions and answers have been edited for style, clarity and conciseness.

For the full interview, please visit pionline.com/ariel.

Stephen J. Serio

Partnership: John W. Rogers Jr. and Mellody Hobson said Ariel’s co-leadership model is a source of the firm’s strength.

P&I: Investors are extremely nervous, bracing for a tough economic and market environment this year. Is a recession around the corner, as many predict?

John W. Rogers: Well, I think that no one ever knows whether you’re going to have a recession or not.

And as you know, we are long, long-term investors, so we realize if we do have a recession, we will recover from that recession.
We’re always just trying to keep our eye on the long-term perspective of what’s going to happen in America. We agree with Warren Buffet that our capitalist democracy is the best system ever invented.

And so you’ll have these ups and downs and they’re really unpredictable. At the end of the day, we’re optimistic.

Does that mean that the Federal Reserve is close to being done with its tightening cycle, and are we going to see rate cuts later this year?

John W. Rogers: We don’t think there’s a strong mistake being made by anyone, and we do believe that as time goes forward, rates will start to slowly but surely decline as we get inflation under control. I’m confident that we’re in a good place.

Mellody Hobson: Should we have a recession, one of the things that we’ve said is it would probably not be a hard landing. It would probably be a softer one because corporate balance sheets are very strong, and the American consumer is still in really good shape. They’re still spending down the stimulus money that they got a couple years ago.

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.

How have you taken advantage of the eruptions in capital markets in the wake of Silicon Valley Bank? 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). Those kind of light cyclicals we think are very cheap in this environment.

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 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 midsized 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.

So you do hold these companies accountable?

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. 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.

‘We’ve told companies we can’t invest in you if you are running yourself like a 1940s company ... that’s just not going to work for us.’
John W. Rogers Jr.

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 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 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.

Let’s talk about long-term value investing, which is your bread and butter. 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.

There’s a lot of great value-related companies, but they were so overlooked in the last decade. They’ve become so cheap that 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.

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.

Speaking of COVID, what surprised you the most about the financial markets?

John W. Rogers: The surprise was how quickly we adapted. 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.

Let’s talk about emerging markets and how your new team is developing.

Mellody Hobson: We’re very, very excited about this new asset class for us. We also think the timing is very good.

EMV, emerging markets value, has been out of favor and we’re contrarians, you know — that’s when we think you have the best opportunity to outperform. And so we’re eager to get started with them. And we’ve done this before. We did it successfully with international and global and that was 12 years ago.

It’s very important for firms to learn something new. I think that that’s important — that you grow and you stay curious about new things. And while of course our international and global team has emerging markets exposure, having a dedicated EMV strategy will be a great new thing for the firm.

P&I is celebrating its 50th anniversary this year. Ariel is celebrating its 40th. What do you consider the most seismic market changes you’ve witnessed over the firm’s 40 years, and how did Ariel meet those events?

John W. Rogers: The first one, of course, was when the stock market crashed in 1987, and was down 22% in one day. There was this extraordinary amount of fear.

But for us, the firm just being 4 years old, it gave us an opportunity to show people that we were true contrarians. That we were going to live John Templeton’s values of buying when there’s maximum pessimism, or as Warren Buffet says, you want to be greedy when others are fearful.

So we were able to then call clients during that day and say, send us more money. We found this is a once-in-a-lifetime opportunity to buy bargains and it just showed what we were really about and that we were going to live our values under immense stress.

But we were able to find some great, great bargains that set us up for really a great recovery and great returns for the rest of ’87 and into ’88. And then, of course, the other financial crisis that lasted much longer was the 2008 and 2009 crisis — the lows got tested more than once. It was absolutely brutal.

It tested us a lot because we were losing clients during that period. At the same time, we were underperforming, and that put a lot of stress on all of us. But the good news there is, again, we went back to our core beliefs, and bought while there was this sheer panic in the marketplaces and really got some extraordinary companies at throwaway prices.

So again, in ’08 and ’09, we took advantage of that, during that painful period, bought terrific bargains and ended up being No. 1 in our category coming out of the bottom of that financial crisis.

We’ve just been able to show in those two key periods that if you stick to your guns, clients start to understand that you’re going to be the true value investor in times of turmoil. Our team understands it. And now the cool thing is that now our team is even more battle-tested than ever. You know, all of our senior investment professionals have gone through a financial crisis together.

You talked about being battle-tested. What’s next for Ariel Investments? What’s the next 50 years going to look like?

John W. Rogers: I think Mellody has been leading the vision for the future, which has been great. Mellody calls it Ariel 2.0 and she’s been using her network and her leadership skills, her experience to attract extraordinary talent, both in full-time teammates here and helping us to run Ariel. But then being able to think about new product areas like Project Black, that’s part of Ariel Alternatives, and our new emerging markets team.

That’s all a part of Mellody’s vision. I think when you ask the question about the next 50 years, Ariel will be a more diversified firm than we were.

Mellody Hobson: We’re going slow. The one thing I tell people is we add something every decade. We started small cap in 1983. We started midcap in 1990. We started SMID in 2000. We started international and global in 2011. We started Project Black in 2021, and then EMV is this year.

And so I think that one of the things you hear from us is, whatever we do, it’s almost as if it were a concentric circle. It makes sense. If you hear that we’re doing it, you say, oh, that’s an extension of what they’ve already done. That the international global was an extension of what we had done for so many years in domestic.

Project Black was an extension of us. Many people say because of our long holding periods at Ariel, a decade, two decades for stocks, that we’re like a public-private equity firm, because we have such a long-term horizon. And so Project Black was just another natural extension and when people heard about it, especially around its core thesis, it made sense coming from Ariel.

We will not just offer things for the sake of offering it, and we won’t be a firm with dozens of products. We will never be that. We will be a boutique and in our areas of expertise, we will have people who know those areas in a deep way.

So this is an evolution, part of the evolution of Ariel.

Mellody Hobson: Evolutionary. I also used a term lately that I heard somewhere, it’s a bit of a refounding — refounding in that it has a broader platform, but it’s still around all of our core beliefs and our core values. You’re not hearing us talking about a growth strategy or some kind of rapid trading strategy.

Everything you hear from us is talking about being patient investors, being value investors, buying things when they’re out of favor, seeing long-term growth prospects for those businesses. Everything we’ve added is consistent with those messages.

So, just staying on with Project Black, why the need and how do you see this fitting into improving the wide gap in wealth between Black and white households?

Mellody Hobson: I’ve talked about that a lot. How it came to be, which was a call from Jamie Dimon during the summer of civil unrest where George Floyd was horrifically murdered and he said a lot of people want to help Black businesses. Why? Because if you look at the data, if you look at the wealth gap in this country, the biggest gap exists among Black and brown Americans and white Americans.

That gap is gigantic. We have negative net worth in the Black community vs. our white counterparts at similar income levels. And so as a result of that, we said, how can we go to the area that is most in need?

And to the extent we don’t close that wealth gap for Black and brown people, we have huge repercussions for all of society. So that’s where we went. And then we said, how do we be creative about this?

I had this idea. The idea was could we be tier one suppliers to Fortune 500 companies that are saying, especially at that time when under so much pressure, that they wanted to figuratively and literally diversify their supply chain. Figuratively, because of the need to show that they were inclusive. But also literally after COVID and during COVID where the supply chain had been compromised.

These companies were saying that they wanted to have 10% to 15% of their spend be with diverse suppliers, and yet they were only at 2%. At the same time, 95% of minority business enterprises in this country have less than $5 million in revenue. So even if the big companies wanted to do business with us, we had a scale challenge on our side.

So we said, let’s meet that scale challenge. Let’s go out and buy businesses. Between a hundred million dollars and a billion dollars in revenue, and by virtue of our ownership, my word, minoritize, them by installing a majority minority board, by having members of the C-suite be Black and brown.

‘To the extent we don’t close that wealth gap for Black and brown people, we have huge repercussions for all of society. So that’s where we went. And then we said, how do we be creative about this?’
Mellody Hobson

By sharing equity throughout the organization, by whenever we have the possibility of diversifying doing so in disadvantaged communities, we said we have the opportunity to have a lever here that could actually change outcomes for lots and lots of people.

How will you both measure the success of Project Black?

Mellody Hobson: This is not about anecdotes, this is about metrics. I’m always saying that math has no opinion. So we will be tracking everything right out of the gate in terms of our hiring practices, in terms of the diversity inside of our organizations.

With our first business that we’ve bought, Sorenson, which provides tech-enabled services for the deaf and hard of hearing, we’ve already made tremendous strides.

We have someone responsible for measuring the impact of these businesses and reporting them out to our LPs so that they’re very clear about what is happening.

Here’s a related question to Project Black. So I noticed during the COVID crisis, a lot of Black and brown communities became interested in the financial markets. What do you think about financial literacy for the broader community?

Mellody Hobson: We’ve been big believers that financial literacy is essential to the long-term financial success of our country and the world. And unfortunately, America is financially illiterate because we don’t learn about investing in school. I give this example all the time that you can take wood shop or auto in a high school today and not a class on investing, which always leads me to ask people who is whittling, who is cleaning their own carburetor? No one. And yet that class on investing could have profound effects, not only on the individual but on future generations.

But the only way to do it is to do it in small bites. And one of the ways that people encounter a lot of their financial knowledge actually is at work. It’s in their 401(k) plan, their 403(b), 457, where they get that list of options and they’re confronted with a choice.

And so using that as a leverage point right now is probably the most obvious and easiest way to try to move the needle in terms of getting, and helping, people to be further along when it comes to being financially literate.

John W. Rogers: The only thing I would add is that during the Obama administration, I had a chance to chair his task force on financial literacy. It was called the Council for Financial Capability for Young Americans, and the concluding documents we gave to the president, we were really trying to inspire financial services companies to partner with urban public schools and utilize the model that we had created with the Ariel Community Academy that was started approximately 25 years ago, where we give the kids real money to invest in real stocks and really learn about what the stock market’s all about, learn about compound interest, learn about entrepreneurship, learn about job creation and learn about financial services careers.

People always talk about the importance of STEM, which is important, but we know how important financial services are to this country and for some reason we haven’t thought about that, of not only educating people about how to save and invest, but also how to help prepare them for careers in finance where you can create multigenerational wealth and economic opportunity for, particularly, minority students in urban communities.

Mellody, what is the biggest untold story of Mellody Hobson? Just looking at your accomplishments, it’s hard for all of us not to be inspired by and to admire you. Anything else you have your sights on?

Mellody Hobson: I don’t have specific ideas of things that I will do because I try not to limit myself to my own imagination. Because almost everything that has happened to me was beyond anything I could ever imagine. But I do stay open and curious to all possibilities, and I think that’s given me a lot of opportunity. So I can’t tell you in specifics what is to come, but I can tell you that I always dream big.

John W. Rogers: And I would say that one of the things that’s maybe not asked what’s not recognized about her, is that she’s been a real pied piper for talent. I talk about that all the time when I’m giving advice to other companies of how do you build a diverse firm in the 21st century? So you get a leader like Mellody, who can attract the best talent. And we have so many great people leaving great firms and great careers to come join our small firm because they’re inspired by her energy, her commitment to helping others, her commitment to excellence, and everything that she does.

What’s the one important issue or any type of lasting thoughts you’d like to tell the institutional investing community?

John W. Rogers: I think that sometimes because we get more of the visibility, people don’t really understand the depth of the talent that’s here. All these stars that have been here for 10, 20, 30 years or more, and then some that have gone off and left and done wonderful things outside in the world.

Mellody Hobson: I would say the two things, one that is very important is, this is what we love to do. You know, Warren Buffett says do a job that you would do if you didn’t need a job. We love this work. This is what we plan to do. You know, people always ask, what’s next? We just want to be good at this.

Not just good, but great. And being great is a really hard task.

And then the other thing I would say, and I don’t think it gets a lot of attention, I don’t think many companies have a co-leadership model like we do that has worked as effectively as it has. John and I truly love and respect each other.

Even when we disagree, and we disagree a lot, there’s a basic anchor of respect.

That co-leadership model, I’m just shocked more people don’t do it because it works so well for us.

It doesn’t work for everyone.

John W. Rogers: We talk multiple times a day. There’s no decision that I make, business or personal, without coming to Mellody to get her thoughts and her advice and her counsel because of the respect and love I have for her. And the admiration I have for her.

And she’s always going to tell me not always what I want to hear but the things that I need to hear when you’re making some of the toughest decisions that we all have to make in life. I think that’s another part of the story that’s maybe not well understood.