4th Quarter 2010 Commentary - ASTON/Lake Partners LASSO Alternatives Fund
4th Quarter 2010 Commentary
The Fund generated decent returns during the fourth quarter, adding to its solid results for the year-to-date. Its flexible mandate means it may perform differently than either its Morningstar Long-Short Category peer group or its HFRX Equity Hedge Index benchmark from time to time. The Fund outperformed its peer group during the quarter, the calendar year, and since its April 1, 2009 inception. In contrast, the portfolio trailed the benchmark for the quarter, nearly matched it for the calendar year, and has outperformed since inception.
The underperformance relative to the benchmark during the quarter was due to allocations to non-equity related strategies, which have been included for potential diversification and risk reduction purposes. In addition, the benchmark posted a 1.0% gain during the last two days of the calendar year, when the S&P 500 Index was down 0.2%. Historically, hedge fund benchmarks have exhibited idiosyncratic performance over short periods, due to unusual holdings or even potential pricing or accounting anomalies within the underlying funds which comprise such benchmarks. Nevertheless, the Fund still trailed the benchmark by only a fraction by the close of 2010.
As an asset allocation solution for alternative strategies, the Fund has provided investors with returns with less volatility than conventional markets in a liquid format. Since inception its annualized standard deviation of daily returns has been about one-third that of the S&P 500 Index, a standard proxy for the overall market.
Strategy Allocation and Performance
Among equity-related strategies, the pattern that developed during the third quarter continued throughout the fourth quarter. Long-biased hedged equity allocations represented the largest contributor to returns, which is not surprising given the overall rise in equity markets. Managers oriented towards growth and small-cap stocks did especially well. Relatively hedged long/short strategies also participated in the market’s upside, although to a somewhat lesser degree depending on their net equity exposure.
Credit-related strategies continued to add value during the quarter, but to a lesser degree as spreads narrowed. These strategies have tended to display relatively more stable risk/return characteristics than equities, and thus helped to reduce volatility. Strategic fixed-income allocations have served the Fund well as a source of diversification, but as a group their returns were relatively modest as trends began to change. A small position in an interest-rate hedge (short US Treasuries) was productive as yields moved upwards. We have maintained the position due to ongoing concerns associated with massive government debt issuance and deficits.
Recently established positions in managed futures and global macro strategies were a slight drag on performance. These newer positions reflect our continued focus on diversifying the program by including less correlated strategies, and the allocation ranged between 4% and 6% during the fourth quarter. In the aftermath of some of the volatility experienced in November, trend-oriented programs were generally able to reposition and reestablish their exposures and subsequently participate in the upside, while counter-trend programs were out of sync.
Merger arbitrage only generated minor gains. In 2010, merger arbitrage spreads narrowed due to low interest rates and declining volatility, despite an increase in deal activity. We continued to reduce the portfolio's allocation to this strategy due to modest performance. During the quarter, the stake in merger arbitrage holdings declined from 11% to 5% of assets.
Throughout the year we positioned the portfolio to dampen the risk of conventional asset classes while maintaining the potential for relatively stable returns via less conventional strategies. During the last six months we have been proactive in adjusting the overall mix of strategies through an incremental approach as opportunities have shifted, evident from the managed futures and merger arbitrage examples above and the following update.
After credit spreads widened mid-year, we trimmed the Fund's allocation to strategic fixed-income strategies in favor of hedged credit strategies. This proved to be a productive shift as market conditions subsequently improved. During the fourth quarter, we trimmed the allocation to hedged-credit (from 24.0% to 21.2%) as spreads in the U.S. high yield market narrowed again. We also reduced the portfolio's allocation to strategic income (from 13.5% to approximately 11.0%) in the face of rising bond yields. Hedged fixed-income strategies remain an important part of the portfolio due to their relatively stable risk-return profile compared with equities.
At the margin we have continued to top up long-biased allocations within equity-related strategies. Earlier in 2010, volatility created buying opportunities in equities. In particular, we slowly increased long-biased equity strategies from approximately 17.5% in mid-June to 23% at the beginning of the fourth quarter and 31.8% by year-end—which served investors well as the equity market rebounded. In addition, the Fund held a 13% allocation to US-oriented hedged equity strategies and a 4% allocation to global hedged equity strategies at year-end.
The portfolio also includes small positions in "tail risk" hedges. The prospect of the Federal Reserve Board's quantitative easing program led to a rise in longer-term interest rates during the fourth quarter. We have had a small interest-rate hedge in place for some time to help mitigate potential bond market risks resulting from rising levels of government debt. We also initiated a small hedge prior to year-end against any potential rise in volatility. As equity market volatility declined during the fourth quarter, so did the cost of such a hedge, but the potential for unexpected volatility remains given sovereign debt concerns and geopolitical uncertainty.
Overall, the Fund remains reasonably hedged with an approximate net equity exposure of slightly more than 40% as of year-end.
The investment environment is continuing to improve slowly—or not so slowly, in the case of December, when the S&P 500 jumped 6.7%. Based on economic and corporate sector fundamentals, there is support for further optimism. According to Thomson Reuters, "Standard & Poor’s 500 companies are expected to earn a record $95.98 per share in 2011…that would exceed the 2006 per-share record of $88.12.”
However, this optimistic view must be tempered by a bit of sober realism: the recovery must become sustainable without fiscal and monetary stimulus. Serious structural issues remain unresolved, including the US deficit, Europe’s credit woes, Japan’s disinflation, and China's mercantilist currency policy. Judicious risk management and careful diversification, components integral to the Fund’s process, therefore continue to be important.
Lake Partners, Inc.
Note: The Fund is a fund-of-funds, and by investing in the Fund you incur the expenses and risks of the underlying funds it invests in. Potential risks from exposure to the underlying funds includes the use of aggressive investment techniques and instruments such as options and futures, derivatives, commodities, credit-risk, leverage, and short-sales that taken alone are considered riskier than conventional market strategies. Use of aggressive investment techniques including short sales may expose an underlying fund to potentially dramatic changes (losses) in the value of its portfolio. Short sales may involve the risk that an underlying fund will incur a loss by subsequently buying a security at a higher price than the price at which the fund previously sold the security short.
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.