1st Quarter 2013 Commentary - ASTON/Fairpointe Mid Cap Fund
1st Quarter 2013
The performance of U.S. stocks was quite strong during the first quarter of 2013, as the relative strength and stability of the U.S. economy attracted investors away from weaker and less stable regions of the global economy. Mid-cap stocks outperformed large- and small-cap stocks as the Fund’s S&P MidCap 400 Index benchmark gained 13.5% compared with returns of 10.6% for the broad market and large-cap oriented S&P 500 Index and 12.4% for the small-cap Russell 2000 Index.
The Fund’s returns were even stronger. The performance contribution was broad-based with 25 stocks in the portfolio up more than 10% and only two stocks down more than 10%. Tax preparation firm H&R Block was the best performer during the quarter as an improving employment outlook and successful cost saving efforts provided catalysts to unlock value that the company had built as it refocused on its core tax business. We trimmed the Fund’s position due to valuation following the run-up in its price.
The next top contributors were Boston Scientific and Cree. Boston Scientific experienced improved pricing trends for its cardiovascular products and continued to buy back shares of its own stock. Cree is a leading supplier of LED lighting products that raised guidance and introduced a new lower-priced LED bulb that should drive faster adoption of this new technology.
Notable detractors from performance included Akamai Technologies and CGGVeritas (Cie Gen Geophysique), both having declined more than 10% during the quarter. Although results for the period met expectations, Akamai announced that it plans to ramp up investments in sales and marketing to broaden its customer base, leading to reduced near-term earnings. CGG is a manufacturer of geophysical equipment and provider of seismic data that has been a relatively small holding within the Fund. Among other stocks with smaller declines that had little impact on overall performance were Nuance Communications, Jabil Circuit, and Harris Corp.
The significant appreciation in the U.S. stock market over the past few months presents an interesting environment for investors. With the market’s recent performance, it is difficult not to expect or prepare for a correction. But how do you prepare for such a possibility? To achieve long-term performance goals, it is important to follow a consistent approach when choosing investments. It is also imperative to remain focused on the long-term prospects of companies without ignoring short-term developments. A key way that we achieve this is by paying close attention to the changing valuation of the portfolio’s holdings and adjusting them accordingly.
For example, we first purchased healthcare firm Hospira for the Fund in October 2011. Hospira is the world’s leading provider of injectable drugs and infusion technologies, with its injectable division a niche category within the generic pharmaceuticals market. Injectable pharmaceuticals require advanced expertise, and thus possess greater barriers to entry than oral generics.
Hospira’s stock had declined nearly 50% in the three months preceding the Fund’s investment primarily due to manufacturing issues and a warning letter from the U.S. Food & Drug Administration (FDA) relating to its Rocky Mount, North Carolina facility. Margins, cash flow, and earnings became depressed as the company corrected these issues. We maintained that the manufacturing issues encountered by Hospira were fixable, and that these issues gave us the opportunity to purchase a market leader with good global growth prospects at an attractive valuation. The manufacturing issues that led to the FDA warning letter related to poor documentation and processes rather than bad product. Moreover, many of the drugs that the company manufactures are in short supply, and we think the FDA would be reticent to take harsh action and limit supply further. We were comfortable with the risk/reward profile that Hospira presented at the time, as well as its current valuation, and believe that our patience will eventually be rewarded.
Positioning and Outlook
There were two new purchases and one sale of note during the quarter. We initiated a position in in leading offshore oil and gas construction firm McDermott International as well as First Solar, a supplier of solar power components and systems. We sold long-time holding Mentor Graphics after it reached our price target.
We expect worldwide economic growth to continue at a moderate pace, though not without some difficulties. Europe continues to deal with one crisis after another, China is growing but expectations have been scaled back, and Japan is implementing more aggressive stimulus programs. In the U.S., trends for housing, employment, and auto sales are up but may experience short-term setbacks, while sequestration and implementation of healthcare reform add some uncertainty to the outlook.
Valuation metrics for the portfolio have become richer along with that of the overall market. We continue to trim positions when stock valuations are high and add to positions with more attractive prices. We believe that with the market move we have seen thus far in 2013, stock selection has become even more important. We remain focused, and endeavor to reposition the Fund to maintain attractive valuations relative to its benchmark and the S&P 500.
Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager
As of March 31, 2013, H&R Block comprised 2.27% of the portfolio’s assets, Boston Scientific – 4.39%, Cree – 2.65%, Akamai Technologies – 2.54%, Cie Gen Geophysique – 0.73%, Nuance Communications – 2.30%, Jabil Circuit – 2.09%, Harris Corp. – 1.49%, Hospira – 3.82%, McDermott International – 2.20%, and First Solar – 1.40%.
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.