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Jul 15 2013

2nd Quarter 2013 Commentary - ASTON/Lake Partners LASSO Alternatives

2nd Quarter 2013

The second quarter was a tale of two markets. For much of the first half of the period, equity and credit markets continued to trend higher on a combination of momentum, improving sentiment, stable corporate fundamentals, decent economic data, and supportive monetary policy not only in the U.S. but also Japan. Markets reversed course sharply beginning in mid-May, however, as investors reacted with alarm to a sudden barrage of news that was widely interpreted as having negative implications. Federal Reserve chairman Ben Bernanke’s testimony before Congress raised the likelihood of “tapering” its quantitative easing (QE) program, the Bank of Japan announced that it would not expand its easing measures, and China’s manufacturing sector showed signs of slowing. The initial sell off in both the stock and bond markets was followed by a brief period of uneasy sideways trading, only to succumb to another bout of sharp downside volatility after Bernanke’s June 19 press conference re-ignited fears of Fed tapering. Signs of tightening by the People’s Bank of China, as well as further indications that China’s economy was slowing, added to investor concerns.

The re-appearance of downside volatility was widespread, as it affected equity, fixed-income, credit, currency, and commodity markets. Perhaps the most unexpected downturns, and thus the most upsetting for many investors, occurred in fixed-income and credit. Most significantly, the yield on 10-year US Treasuries rose nearly a full percentage point from a low of 1.63% on May 2 to a high of 2.61% on June 25. The domino effect was felt throughout credit markets as high-yield Corporate bonds sold off, mortgage-backed securities corrected, Emerging Market debt was hit hard, and Treasury Inflation-Protected Securities (TIPS) cratered. 

Positive Equities
The Fund was nearly flat for the second quarter in outperforming its HFRX Equity Hedge Index benchmark. U.S.-focused long-biased and long/short equity-oriented allocations made a positive contribution. Most notably, multi-asset, and opportunistic funds either matched the return of the broad market S&P 500 Index or outperformed it by a wide margin. Although the portfolio’s holding in a highly-hedged core manager was flat for the period, it was effective in dampening volatility. Interestingly, in the global equity area, a highly-hedged Emerging Markets holding finished the quarter up, while a long-biased Emerging Markets manager was down only slightly.

Hedged Credit and Strategic Fixed Income strategies faced increasingly challenging conditions during the later part of the period as bond yields backed up and market liquidity thinned out in response to selling pressures, especially within Emerging Markets. Some of the holdings in the portfolio that were more hedged were better positioned to protect against the downside, but others were more exposed and served as a drag on performance. Nevertheless, all of the Fund’s fixed-income holdings outperformed the broad market Barclays Capital Aggregate Bond Index during the quarter.

Elsewhere, Merger Arbitrage succeeded in generating steady, positive results as corporate events tended to be more relevant to the portfolio than market action. Convertible Arbitrage displayed a relatively stable risk/return profile for much of the quarter, but slipped slightly into negative territory at the end of June. Within our Global Macro category, the portfolio’s sole holding participated in the bulk of the market’s rise early in the quarter, but then was unable to escape the effects of the negative investment environment later in the period. The fund finished the quarter off marginally, even though the manager had diversified across a wide range of eclectic sub-strategies in multiple asset classes. 

Portfolio Allocations
Due to the ongoing potential for renewed volatility in the financial markets, we maintained the Fund’s net long equity exposure in the 30% range during the quarter. This was supported by the relatively defensive stance of some of our core managers, and the continued inclusion of non-equity related strategies (long/short credit, strategic fixed income, and global macro).

Strategy allocations were largely stable for much of the quarter. The core of the portfolio continued to be represented by a diverse set of equity-oriented allocations that accounted for nearly half of the portfolio. Although this is the largest single strategy allocation in the Fund, it is important to note that this broad category encompasses a diverse mix of long-biased, hedged, multi-asset, and global strategies. Within this general category, we did implement several modest-sized re-allocations during the quarter in order to broaden diversification, primarily by rebalancing among the core managers in the group as well as trimming from our Global Hedged Equity category.

We scaled back allocations to Hedged Credit and Strategic Fixed Income strategies as a result of the volatility in credit markets during June from a combined 32.5% at the end of March to less than 27% at the end of June. This involved trimming three funds that exhibited larger-than-expected downside, while adding to one fund that had a more defensive risk/return profile.

We also reduced the allocation to Global Macro strategies, again due to larger-than-expected downside. We have continued to avoid long/short commodities and trend-following strategies as many of the strategies in these areas remain out of sync with the market. In contrast, we increased the allocation to a holding in Merger Arbitrage that has been able to add value by emphasizing smaller transactions. That raised the overall weighting of the arbitrage categories to 12.5%.

As a consequence of these various reallocations across the different strategies, the Fund’s cash reserve exceeded 7% at the end of June. This did not represent a strategic allocation, but a residual of recent activity that is intended to be only temporary. 

Outlook
For much of the first half of 2013, market trends demonstrated how liquidity and momentum can be powerful forces as volatility in equity markets diminished to levels not seen since before the global financial crisis. Underpinning this trend was the fact that central banks of developed economies had played their cards well as quantitative easing and accommodation trumped fiscal constraints and slow progress on structural reform. The “deck” still included a variety of “wild cards”, however, including the eventual “tapering” of QE by the Fed as well as dour economic news. When the luck of the draw changed for investors, confidence turned to concern, and in some markets ebullience turned to outright panic. What remains to be seen is if investors have overreacted, or whether there has been a real sea change. Either way, volatility is likely to be elevated in the interim.

Longer term, the outlook is relatively positive, as the global economy is expected to “muddle through,” U.S. corporate cash flows and balance sheets are strong, and equity valuations generally fair. In the near term, though, market trends may remain subject to policy and political uncertainties. We therefore are maintaining a diversified mix of equity-oriented, credit-oriented, arbitrage, and macro strategies, with different degrees of correlation and market sensitivity. We believe that the Fund is well positioned to deliver on its goal of producing attractive risk-adjusted returns over time. 

Lake Partners, Inc.
Stamford, Connecticut


Note: The Fund is a fund-of-funds, and by investing in the Fund you incur the expenses and risks of the underlying funds it invests in. Potential risks from exposure to the underlying funds include the use of aggressive investment techniques and instruments such as options and futures, derivatives, commodities, credit-risk, leverage, and short-sales that taken alone are considered riskier than conventional market strategies. Use of aggressive investment techniques including short sales may expose an underlying fund to potentially dramatic changes (losses) in the value of its portfolio. Short sales may involve the risk that an underlying fund will incur a loss by subsequently buying a security at a higher price than the price at which the fund previously sold the security short.

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.

Resources

Aston History (228 KB, PDF)
Capabilities Brochure (4 MB, PDF)
Aston Style Box (41 KB, PDF)
Aston Subadvisers (436 KB, PDF)
Sales Map .pdf (2 MB, PDF)

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