2nd Quarter 2014 Commentary - ASTON/Silvercrest Small Cap Fund
2nd Quarter 2014
The 5% to 6% increase in U.S. equities, depending on one’s choice of index, reflected a sanguine second quarter. U.S. equity investors shrugged off the quarter’s chief anxieties: violence in Ukraine, the slowdown in China, deflation in Europe, a first-quarter contraction of U.S. gross domestic product (GDP), and anxiety about whether the Federal Reserve (the Fed) will raise rates sooner than investors expect.
For small-cap stocks within the Russell 2000 Value Index, Utilities and Energy were strong outperforming sectors, continuing the first quarter’s trend. On the downside, Materials, Technology, and Consumer Staples were relative laggards. Quality trends were mixed for the quarter but an overall modest bias toward higher quality issues helped the Fund’s relative performance.
The Fund outperformed the Russell 2000 Value Index benchmark during the quarter. Sector allocation in terms of over- and underweight positions did not have a material impact on the Fund’s relative performance. Encouragingly, the Fund’s relative sector performance improved over a poor first quarter, outperforming in five of nine sectors. The best relative performance came from the Energy sector, led by Bonanza Creek Energy. The company responded favorably to news of acreage expansion in the Wattenberg Field. Within the Producer Durables sector, US Ecology gained after announcing the proposed acquisition of EQ - The Environmental Quality Company, in a deal that appears to make great strategic and financial sense.
The Fund’s weakest relative sector performance came from the Materials sector. Within the sector, Stepan Company has missed earnings forecasts for several quarters and has reduced guidance. We have concluded that Stepan is not quite as appealing as a specialty chemical company as we had originally thought upon initiation into the portfolio. Accordingly, with our conviction relatively low for a near-term turnaround, we have decided to sell our holding to redeploy the assets in higher conviction ideas. The Fund also performed relatively poorly in Utilities, where MGE Energy was a weak performer.
Buys and Sells
New positions purchased during the quarter included Matador Resources and Standex International Corp. Matador is an independent oil and gas exploration and production company focused on unconventional (shale) oil production in the Eagle Ford and Permian basins. We like Matador’s management and believe the company can successfully exploit its acreage positioning; we find the shares attractive at roughly peer group valuations.
Standex is a multi-industry company we have followed for several years. About half of the company’s profits come from the commercial food service equipment markets, with the balance from industrial, automotive, and aerospace markets. The company has restructured its portfolio of businesses over the past few years, which has led to significant margin improvement. We see opportunity for further margin expansion through restructuring and consolidation. Shares of Standex are underfollowed by analysts on Wall Street, with only one sell-side firm covering the company. We think one priority of the new CEO will be to increase the visibility of the company among the investment community, which could be a potential catalyst for multiple expansion.
We eliminated holdings of Drew Industries, ReachLocal, and Stepan Co. during the period. We sold Drew as it appeared fairly to modestly overvalued following solid performance over the past year. Reluctantly, we decided to eliminate the Fund’s small holding of ReachLocal, as the revamping of the sales force under a new CEO injected greater risk into the investment thesis.
We think the Fund’s portfolio is reasonably valued given the current levels of interest rates, inflation, and corporate balance sheet strength. We are encouraged by the recent uptick in merger and acquisition activity, and we believe there is increasing pressure, in part fueled by activist investors, for companies to redeploy seemingly excessive levels of cash on corporate balance sheets. We remain convinced that many of the Fund’s holdings would make attractive acquisition targets for larger companies or private equity investors. In meetings with company management teams, it appears that economic trends in the U.S. continue to improve, with stabilization continuing in Europe. As we reported last quarter, trends in China appear more mixed. While a market correction can occur at any time, with pundits competing to handicap the odds of the Fed tightening and the assumed negative impact on equities, we remain reasonably optimistic that over the balance of the year we can potentially build on the gains of the first half.
Silvercrest Asset Management Group
New York, NY
As of June 30, 2014, Bonanza Creek Energy comprised 1.70% of the portfolio’s assets, US Ecology – 2.77%, EQ - The Environmental Quality Company – 0.00%, MGE Energy – 1.66%, Matador Resources – 1.71%, and Standex International Corp. – 1.61%.
Note: Small-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.