The RNA-induced transcriptional silencing (RITS) complex, containing Ago1, Chp1, Tas3 and centromeric small interfering RNAs (siRNAs), is required for heterochromatic gene silencing at centromeres. Here, we identify a second fission yeast Argonaute complex (Argonaute siRNA chaperone, ARC), which contains, in addition to Ago1, two previously uncharacterized proteins, Arb1 and Arb2, both of which are required for histone H3 Lys9 (H3-K9) methylation, heterochromatin assembly and siRNA generation. Furthermore, whereas siRNAs in the RITS complex are mostly single-stranded, siRNAs associated with ARC are mostly double-stranded, indicating that Arb1 and Arb2 inhibit the release of the siRNA passenger strand from Ago1. Consistent with this observation, purified Arb1 inhibits the slicer activity of Ago1 in vitro, and purified catalytically inactive Ago1 contains only double-stranded siRNA. Finally, we show that slicer activity is required for the siRNA-dependent association of Ago1 with chromatin and for the spreading of histone H3-K9 methylation.