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Jul 18 2014

2nd Quarter 2014 Commentary - ASTON/Fairpointe Mid Cap Fund

2nd Quarter 2014 

Following a strong first quarter, the U.S. stock market continued its upward trend during the second quarter of 2014, with most of the performance coming in June. The Fund again delivered solid returns in outperforming its S&P MidCap 400 Index benchmark for the sixth consecutive quarter. 

Polypore Stands Out
Performance contribution remained broad-based with 15 stocks up more than 10% and only four stocks down more than 10%. The top contributor was filtration technology firm Polypore International, which spiked higher after reporting strong first quarter financial results. The company manufactures specialized microporous membranes used in various separation and filtration processes, with its largest market being lead-acid batteries used in automobiles. The company’s membranes are also a key component in lithium batteries used in electric-powered vehicles, a potentially large growth market. We view the new electric vehicles from Mercedes Benz, BMW and others, as positive signs of increasing demand for electric-drive vehicles.

Cooper Tire & Rubber was another strong performer after beating earnings estimates. The company recently held its first investor day in five years with a goal of sending the message that Cooper managed through the economic downturn and that it is a different company today—more focused and with the ability to grow. We see the resolution of a Chinese joint venture ownership issue as a potential positive catalyst during the third quarter.

Rounding out the top-five contributors were FMC Technologies, Edwards Lifesciences, and Con-way. Energy services company FMC benefitted from strong quarterly results, increased guidance, and a record order backlog in their Subsea segment. Edwards surged following FDA approval of its new heart valve, while trucking company Con-way rose on a stronger freight market and improved margins. 

Unisys Weakness
The primary detractors during the second quarter included Unisys, The New York Times Company, and Raymond James Financial. IT service firm Unisys was the portfolio’s worst performer after it reported a sequentially weaker than expected first quarter. We expect business to improve over the balance of the year and are positive on new cloud-based and cyber security products. We increased the position during the quarter based on its attractive valuation. 

While advertising and circulation revenues increased for New York Times during the first quarter, and it added more digital subscribers than in any quarter in 2013 (now at 799,000 paid digital-only subscribers), the company guided for weaker second quarter advertising revenues, putting pressure on the stock. We had reduced the portfolio’s position prior to the earnings call.

Raymond James declined as investors became concerned about lower commission revenues. We believe these concerns are overdone as commissions account for only a portion of the firm's business mix and the overall revenue stream is much more stable than investors recognize. We added to the position during the quarter.

Other notable detractors were semiconductor manufacturer Cree and telecom infrastructure supplier Juniper Networks. Cree is a significant participant in the LED (light-emitting diode) lighting market, and we think will benefit as adoption of LED technology accelerates. Declining gross margins have been an overhang on the stock, though we expect improvements as the company implements cost cutting measures. Juniper pulled back after strong first quarter performance. We think the company is well positioned to benefit from renewed demand in IT network spending. We added to both positions during the quarter. 

Portfolio Changes
Three new positions were initiated in the portfolio during the quarter—Owens Corning, Teradata, and Time. Owens Corning is a world leader in composite and building materials using glass fiber technology. We expect the company to benefit from an uptick in U.S. residential and commercial construction as the economy improves. The company is currently trading at the low end of its five-year price/earnings range. Teradata provides databases and tools to analyze massive amounts of data, often referred to as “big data”.  We think the stock is attractively valued on a price/earnings and price/sales basis.

Leading U.S. magazine publisher (in terms of advertising revenue share) Time spun out from Time Warner in June. The company publishes more than 90 magazines globally including brands such as People, Sports Illustrated, and Time. Prior to the spin out, the company brought in a very talented and well-respected management team that we believe will execute a balanced approach between cost cutting and growth initiatives. We think the valuation is attractive relative to similar companies.

Five positions were eliminated from the portfolio during the quarter—CGG, Boston Scientific, Southwest Airlines, Sigma-Aldrich, and Zebra Technologies. Geophysical equipment maker CGG was sold based on changing fundamentals in the seismic mapping industry. The other four stocks met our valuation targets. Medical device company Boston Scientific gained more than 125% the last two years as restructuring efforts took hold. Southwest surged even more during that period as industry capacity levels increased due to a better economy. Life-science company Sigma-Aldrich saw significant results with improved operating efficiencies and increased revenues by refocusing the business over the past few years. Finally, we sold long-term holding Zebra Technologies based on valuation and integration concerns after the company announced an agreement to acquire Motorola Solutions’ enterprise business. The stock was up significantly the last two years as well. 

Perspective and Outlook
The trends we have recently commented on have continued to hold sway. Interest rates remain at low levels, auto sales and housing are recovering, employment is increasing and consumer spending is picking up. Manufacturing is expanding in North America due to a competitive cost environment. The European Central Bank and the US Federal Reserve are both maintaining low interest rate policies. Although the economic outlook is positive, we would not be surprised to see a correction based on geopolitical tensions escalating. For example, the situation in Syria and Iraq may cause oil prices to rise, acting as a brake on economic growth. 

The strength in the economy has led to many stocks trading at relatively high valuations.  Despite the overall level of valuations, however, we continue to find undervalued stocks. We focus on identifying companies with leading market positions and strong balance sheets that are inefficiently priced. By actively rebalancing our holdings and replacing overvalued holdings with cheaper stocks, we have managed to keep the portfolio attractively valued relative to the Fund’s mid-cap benchmark. 

Fairpointe Capital

Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager

 


As of June 30, 2014, Polypore International comprised 2.99% of the portfolio’s assets, Cooper Tire & Rubber – 3.01%, FMC Technologies – 2.87%, Edward Lifesciences – 1.73%, Con-Way – 1.76%, Unisys – 1.48%, The New York Times Company – 2.33%, Raymond James Financial – 2.21%, Cree – 2.28%, Juniper Networks – 2.81%, Owen Corning – 3.17%, Teradata – 2.33%, and Time – 0.77%.

Note: Mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.

Before investing, consider the Fund’s investment objectives, risks, charges, and expenses. Contact 800 992-8151 for a prospectus or summary prospectus containing this and other information. Please, read it carefully. Aston Funds are distributed by Foreside Funds Distributors LLC.

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