2nd Quarter 2014 Commentary - ASTON/Cornerstone Large Cap Value Fund
2nd Quarter 2014
Following a rewarding 2013 and a turbulent first quarter of 2014, the market ended the second quarter up by more than 5%, as measured by Russell 1000 Value Index benchmark. Expectations for future U.S. gross domestic product (GDP) growth continue to increase, as gains in asset prices boost household wealth and the drag from fiscal policy continues to lighten. However, slower-than-expected current U.S. economic expansion, low dispersion in stock returns, continued geopolitical unease, and higher corporate buyback levels have made 2014 a hard year so far for active fund managers.
During the second quarter, the most attractively valued stocks based on our proprietary valuation methodology performed the worst, while fairly valued and expensive stocks performed best on average. Generally speaking, the five-year bull market has put the overall market close to fair value. Nevertheless, Cornerstone believes that we are able to find value in those companies that have shown long-term profitability, and we continue to identify attractive opportunities within our universe.
All 10 sectors within the Russell 1000 Value finished the quarter in positive territory. Information Technology, Energy and Utilities were the three best performing sectors in the Russell 1000 Value. On the downside, Consumer Staples, Financials and Telecommunication Services were the three sectors within the index that detracted from the overall performance.
Consumer and Tech Woes
The Fund underperformed its benchmark during the period owing mainly to stock selection within Consumer Discretionary and Information Technology, an underweight in Energy, and no exposure to the Utilities sector, which was the third-best performing sector in the index.
Bed, Bath & Beyond and Mattel were the portfolio’s two worst performing stocks for the second quarter in a row. Concerns over top-line deceleration, gross margin erosion and increased spending on technology led several Wall Street analysts to downgrade Bed, Bath & Beyond. We believe that the market’s perceived threats to the company’s business model, including online retailing and the use of couponing, are overblown and are incorporated in the historical earnings and growth level of this premier retailer. These concerns are more than priced into the stock and we continue to view the stock favorably and added to our position during the quarter. Mattel was another laggard from within the Consumer Discretionary sector. The company posted below consensus estimates for the first quarter reporting period citing weakness in Barbie and its Fisher-Price brands. Additionally, Mattel experienced weaker gross margins as the company reduced its owned inventory during the quarter.
While an overweight position in Information Technology helped the Fund’s performance for the quarter, stock selection detracted from results, as EMC and Oracle underperformed. EMC, a top performer during the first quarter, reported in-line quarterly results during April, and the stock sold off slightly on the lack of an upside beat. Near-term concerns over gross margin declines in the storage business remain a drag on short-term performance. Longer-term, management remains committed to returning 50% of free cash flow to investors in the form of buybacks and dividends. Oracle lagged during the second quarter following two consecutive quarters of being one of the top performing stocks in the portfolio. The company posted a modestly disappointing quarterly report citing weakness in its core database business and lower overall operating margins. Longer-term, Oracle continues its migration to the cloud where it is already highly competitive.
The top contributing sectors for the quarter were the Financials and Health Care sectors. Underweight positions in both Financials and Health Care also helped drive results. Energy positions in the portfolio represented four of the top 10 strongest performing holdings during the period. Royal Dutch Shell was the best-performing stock in the portfolio for the quarter. Cornerstone’s key energy sector holdings are positively correlated to commodity prices in crude oil, which rose over 4% during the quarter from greater insecurity in key oil regions.
Chevron also performed well during the quarter, as both spot and future prices for oil increased during June. The company announced weaker-than-expected first quarter results, but the stock performed well in the following days as investors focused on longer-term potential and the company announced further expansion of a joint venture in Argentina. In our view, Chevron is well-positioned to continue its strong operating performance with its strong and diverse asset portfolio.
Buys and Sells
During the second quarter, we added three new names to the portfolio (Cisco Systems, Ensco and TRW Automotive) and exited three positions (Google, Hasbro and IBM).
Cisco Systems designs, manufactures and sells networking equipment. Cisco has been at the center of the Internet for three decades and has constantly had to progress in order to remain relevant. The stock comfortably ranks in the top quintile across all measures of valuation with what looks like very reasonable inputs and, as a result, we added the stock to the portfolio.
Ensco provides offshore contract drilling services to the oil and gas industry worldwide. The company is recognized as one of the best run offshore drillers in the industry with high quality assets, a strong balance sheet and a sound management team. Additionally, the company produces industry-leading operating margins and returns cash to shareholders through a healthy dividend. Near-term concerns over weak day-rate pricing have caused Ensco to underperform the market and the peer group over the past two years. As a result, the stock looks as attractive as ever on CIP’s valuation work and we initiated a position in the portfolio.
TRW Automotive is an auto parts supplier and global leader in auto safety. Company sales are fairly concentrated to four large original equipment manufacturers, which account for over 60% of sales. Having shored up its balance sheet over the last few years, TRW is now well-positioned over the long-term to benefit from increased auto sales and increased dollar content per vehicle as safety features become a larger part of the vehicle, especially in emerging markets.
Google, a long-term holding in the portfolio, has been a strong contributor to performance since we initiated a position in mid-year 2010. While the valuation case is still compelling, it is contingent upon a very high growth rate. In addition, many of the negatives that, in our opinion, had been holding the stock back have abated and given way to more bullish sentiment. In other words, we felt our investment thesis had played out well on this name and we exited the position.
Hasbro is a stock that has been in the portfolio since May 2012. Our investment thesis at the time identified Hasbro as a well-run, industry leading global toy company with very strong brand recognition and a history of success. Over the past two years, the company has executed well on its business plan in both toys and expanding its branded play franchise. As our investment thesis has played out, the valuation is now less attractive on our proprietary valuation methodology and, as a result, we decided to eliminate the position.
IBM, the portfolio’s longest tenured holding, was exited as the investment team became increasingly concerned about the company’s quality of earnings. Our confidence in IBM’s valuation is low and we see more attractive opportunities elsewhere.
Despite the short-term dislocation in the market’s performance and our estimates of value, we remain focused on our process. Within the 800 stock universe from which we select candidates for investment, approximately 370 stocks still remain undervalued in our estimation, with the median stock price trading near our estimate of its fair value. As disciplined investors, we continue to stick to our investment philosophy, which we think is simple, sensible and has proven its worth over the long term. We believe that volatile periods, when stock prices diverge from the company fundamental value, create compelling opportunities for long-term performance.
Cornerstone Investment Partners
As of June 30, 2014, Bed, Bath & Beyond comprised 3.37% of the portfolio’s assets, Mattel – 4.05%, EMC – 3.35%, Oracle – 4.06%, Royal Dutch Shell – 2.52%, Chevron – 4.19%, Cisco Systems – 2.96%, Ensco – 2.08%, and TRW Automotive – 2.09%.
Note: Value investing often involves buying the stocks of companies that are currently out of favor that may decline further.
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.