3rd Quarter 2012 Commentary - ASTON/Silvercrest Small Cap Fund
3rd Quarter 2012
Macroeconomic news drove the prices of equities higher during the third quarter. European Central Bank (ECB) President Mario Draghi asserted that the central bank would do, “whatever it takes to preserve the Euro,” while towards the end of the period the U.S. Federal Reserve rolled out its latest installment of quantitative easing (QE3). Although it was a “risk on” quarter for equity markets in general given the central bank statements, the quality trends that we track showed mixed results. Value stocks within the Russell 2000 Index modestly outperformed growth, owing largely to the vast outperformance of the Financials sector relative to Technology. According to analyses by Bank of America Merrill Lynch and Credit Suisse, however, companies with the highest expected growth rates performed the best during the quarter.
Within the Fund’s Russell 2000 Value Index benchmark, Materials was far and away the best performing sector, well ahead of the next two areas of the market—Energy and Consumer Discretionary. Within Materials, gold stocks rallied more than 50%, likely a reflection of concerns about global central banks “printing” money, making them the largest contributor to returns. The weakest performing sectors were the less-cyclical Consumer Staples (+1%) and, somewhat surprisingly, the more-cyclical Industrials sector where transportation companies suffered. The worst performing sector was Technology where concerns over semiconductor capital spending hurt equipment providers.
The Fund lagged its benchmark during the quarter, with the bulk of the relative shortfall coming from poor stock selection in the Financials and Materials sectors. Sector allocation attribution was not terribly significant, but overweight stakes in the underperforming Industrials and Consumer Staples areas detracted from results as well. After strong gains during the second quarter, Innophos Holdings within Materials fell in response to an earnings report that failed to meet expectations and delivered tepid guidance. We believe the disappointment will prove temporary, and are sticking with the holding for now.
Within Financials, security selection and an underweight position (5% versus a benchmark weight of 12%) in real estate investment trusts (REITs) caused much of the damage. Multi-family housing REIT Mid-America Apartment Communities lost ground and industrial EastGroup Properties delivered only meager returns during the quarter. We view both REITs as conservatively capitalized and steady operators. Unfortunately, they tend to underperform in “risk-on” environments.
Other poorly performing Financials included insurance company Protective Life, despite a solid earnings report, and IBERIABANK. IBERIABANK reported uninspiring earnings due to stubbornly high expenses that are making investors skeptical of management’s willingness to reduce costs. Although we are disappointed in the expense line, the bank continues to grow loans organically. Management has a record of delivering on its promises, and we think that expenses are at their peak now that it has undertaken cost-cutting initiatives. We further believe management is becoming fatigued facing shareholder ire over expenses, something that is within their control.
The Fund’s holdings in the Energy sector significantly outperformed on the positive side, led by independent oil and gas company Rosetta Resources. Rosetta posted the biggest individual gain in the portfolio, rebounding strongly amid a firmer commodity environment after being one of our worst performers during the second quarter. The portfolio also outperformed in Healthcare, paced by a strong upward move in medical imaging equipment maker Analogic, which reported earnings far ahead of consensus estimates.
Buys and Sells
We initiated five new holdings during the quarter, including Watts Water, La-Z-Boy, Beacon Roofing, and Forum Energy Technologies. Evidence has been building that the U.S. housing market may at last be improving. Although we shy away from investing in homebuilders directly due to what we perceive as overly aggressive discounting of out-year earnings potential, we think that Watts, a provider of “behind the wall” plumbing products, La-Z-Boy, the iconic furniture manufacturer and retailer, and Beacon, a leading distributor of roofing products stand to benefit from a housing recovery. We are impressed with the management team of energy services company Forum, a stock that also serves as a nice complement to existing exploration and production holdings.
On the sell side, we sold Schnitzer Steel, Maidenform Brands, and Matthews International from the portfolio. All three have had somewhat disappointing fundamental results of late and we felt we could redeploy the assets more effectively elsewhere.
As we enter the latest quarterly earnings reporting cycle, uncertainties abound. Company pre-announcements have skewed decidedly negative, as it appears business slowed globally during late summer. Companies and investors alike appear somewhat skittish in front of an uncertain U.S. election outcome and its effect on taxes and the “fiscal cliff”. We are uncertain how investors may react to the likelihood of a somewhat disappointing earnings season, with possibly tempered forward guidance.
Valuation levels don’t seem to suggest too much enthusiasm either, though perhaps some complacency. We continue to believe there is tremendous intrinsic value in the companies in the portfolio with generally strong cash flows and solid balance sheets that should permit them to take advantage of any opportunities in a modest global growth environment. Although we are disappointed with the Fund’s recent relative performance, we are sticking with the philosophy and process that has served us well as investors over the long haul.
Silvercrest Asset Management Group
New York, NY
As of September 30, 2012, Innophos Holdings comprised 1.95% of the portfolio's assets, Mid-America Apartment Communities – 2.56%, EastGroup Properties – 2.74%, Protective Life – 2.53%, IBERIABANK – 2.00%, Rosetta Resources – 2.76%, Analogic – 2.03%, Watts Water – 1.47%, La-Z-Boy – 1.33%, Beacon Roofing – 1.54%, and Forum Energy Technologies – 2.04%.
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.