2nd Quarter 2010 Commentary - ASTON/TAMRO Diversified Equity Fund
2nd Quarter 2010 Commentary
Correction Continues, But Fundamentals Improving
After rising almost uninterruptedly since the market trough in March 2009, stocks corrected sharply during the second quarter of 2010—wiping out gains from the first quarter. Weakness was widespread across the market-cap spectrum, with large-cap stocks retreating more than small-caps. Sector weakness was severe within the commodity sectors, namely Energy and Materials, but large-cap Financials and small-cap Consumer Discretionary also suffered noticeably. The sharpness of the correction surprised many, but it should not be viewed as unusual when put in the context of the rise from the March 2009 lows. We continue to be optimistic that the economic expansion will progress based on the fiscal and monetary stimulus, low inflation, improving corporate balance sheets, and three quarters of positive economic growth. Although employment growth has been a laggard at this stage in the cycle, hours worked continues to creep upward, increasing the probability that job growth will eventually follow.
The previously identified headwinds of increased regulation and taxation are still a concern and to this we add the potential delay in recovery in Europe. This reinforces our thesis that the overall recovery will be slower than normal, with the sharp correction in stocks corroborating this premise. While we did not expect a linear march upward in stocks, the correction in May and June was more severe than we had expected. There is a silver-lining, however—the improved valuation of many leading companies. Yes, it is a fearful recovery. Still, we remain ever vigilant for attractive long-term investment opportunities.
All sectors of the Fund and its Russell 1000 Index benchmark delivered negative absolute returns during the second quarter. On a relative basis, the portfolio underperformed the benchmark due to negative stock selection across several sectors, including Financials, Materials, Consumer Staples and Utilities. Financial regulation uncertainty weighed on the shares of Bank of America. In addition, two Technology firms stood out as the largest individual detractors—NVIDIA and Dell. Concern that the PC upgrade cycle will not be robust hurt the shares of Dell, as margins were also compressed by higher component costs. NVIDIA fell after management's guidance fell short of the market's expectation for stronger sequential revenue growth in coming quarters.
An overweight stake in Healthcare plus strong stock selection served as the largest positive contributor to relative performance. Best-practice health research firm, and top-holding, Advisory Board Company reported accelerating revenues and management raised guidance for the year. The recent economic turmoil has interrupted the company's growth trajectory from earlier in the decade, but we believe healthcare reform is likely to increase demand for its programs from both existing and new customers.
It is very easy to cite reasons to be fearful about the current environment. We learned long ago not to discuss fundamentals irrespective of valuation, however, and we believe the market has discounted most of the concerns on which investors are focused. We consider the recent downdraft an opportunity to own leading companies in diverse sectors at very attractive values.
Through our bottom-up analysis, we have identified the most opportunities within the Consumer Discretionary sector, followed by Technology and Financials. These sectors represent the largest weightings in the portfolio. The lowest sector weights, on both an absolute and relative basis, are in Telecommunications and Utilities. Rising valuations led us to take profits in some Technology stocks as well as one Energy stock, thereby reducing the weightings of those sectors. The weightings in Consumer Discretionary and Industrials continued to rise as they did throughout the first quarter.
In Consumer Discretionary, homebuilder Lennar and education and media enterprise firm Washington Post Company became full positions during the quarter. Lennar is one of the nation's leading homebuilders, primarily serving first-time and move-up homebuyers. Like most homebuilders, the company suffered through the carnage of the past few years with substantial operating losses and write-offs. While economic risks remain, we think the firm's experienced management team appears to have stabilized results and reduced costs and improved its balance sheet. While most recognized for its namesake newspaper, three of the Washington Post's other business units are more important to its underlying value: Kaplan (education and training), Cable One (rural cable systems), and Post Newsweek Stations (local TV stations). We believe that restructuring efforts and a cyclical slump on top of secular shifts in media have obscured the value of the growing education unit. We expect profitability to improve, and are also attracted to a balance sheet a large net cash position, an overfunded pension plan, as well as a management team and board of directors focused on long-term value creation.
Within Industrials, Corporate Executive Board became a full position. Its core asset is its unique database to which members—mostly Fortune 500 companies—benefit and contribute. The challenge has been maintaining growth rates, but with improving business conditions the number and value of membership subscriptions is likely to increase, which offers a favorable risk-reward proposition at currently depressed valuations.
A number of full positions were sold during the quarter. Berkshire Hathaway, Domino's Pizza, Gannett, and NBTY were sold due to valuation, after significant recent gains. Company-specific execution issues led to the sale of Monsanto, Goldman Sachs, and Alcatel Lucent. Grand Canyon Education, Symantec, and Cbeyond were sold based on changes in industry dynamics that we expect would mitigate opportunities. Finally, Loews and Biomed Realty Trust were sold to make way for more attractive opportunities within their respective sectors.
We do not have a crystal ball that will signal when the correction will have run its course, but we do have confidence in the investments we have identified for the upturn. Overall, the Fund has not veered from its investment strategy, as companies we classify as Leaders or Innovators comprised 87% of portfolio assets as of the end of the quarter.
TAMRO Capital Partners
As of June 30, 2010, Bank of America comprised 2.58% of the portfolio's assets, NVIDIA – 1.59%, Dell – 2.35%, Advisory Board Company – 3.41%, Lennar – 1.51%, Washington Post Company – 2.11%, and Corporate Executive Board – 1.81%.
Note: Small- and mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.