3rd Quarter 2013 Commentary - ASTON/Silvercrest Small Cap Fund
3rd Quarter 2013
The Fund outperformed its Russell 2000 Value Index benchmark during the quarter. We were pleased with the relative outperformance given the headwinds facing our high-quality focused style. This was especially true during the third quarter, as overall it was another“risk-on” quarter with cyclical and lower-quality names tending to outperform. The top performing sectors of the benchmark were Healthcare, driven by a rally in biotechnology stocks, Energy, and Technology. The laggards included Utilities and Financials.
As was true during the second quarter, the Fund’s underweight position in Financials helped relative performance, as did our underweight to the real estate investment trust (REIT) sub-sector of Financials. REITs continued to perform poorly overall amid the rising interest rates surrounding talk of whether the Federal Reserve would taper its quantitative easing bond purchases. The portfolio’s REIT holdings did manage a positive return, however.
Most of the Fund’s relative outperformance came from stock selection, paced by Horace Mann. The insurance company has posted better than consensus results the last few quarters. Lithia Motors was the single best performing stock during the quarter. It posted strong results amid a rebounding sales environment for its new and used cars.
Holdings within Utilities and Healthcare detracted from performance. Portland General Electric declined after a below-expectations quarterly report, while ICU Medical dropped following a lackluster earnings report and ebbing takeout speculation.
Buys and Sells
We initiated a position in EnerNOC, a leading provider of demand response and energy intelligence services, during the quarter. The company develops and provides clean and intelligent power solutions to commercial, institutional and industrial customers, as well as electric power grid operators and utilities. With about 25% of its current market-cap in cash and a strong order backlog, we think earnings can grow strongly over the next few years.
We eliminated positions in Hexcel and Astec Industries. Hexcel appreciated to the largest market-cap in the portfolio and above our comfort zone for continued inclusion in a small-cap strategy. Although Astec appeared undervalued, we had limited conviction and decided to sell the position and use the cash for more compelling ideas.
Looking into the final quarter of 2013 and toward 2014, the broad U.S. economic picture seems constructive. We keep hearing comments from company management teams about a manufacturing renaissance in the U.S., with low or stable energy costs among the factors making the U.S. a compelling place to invest. The near-term, however, seems mired in Beltway posturing as Washington has plunged into a contentious autumn with continuing resolutions a prelude to the important debt-ceiling matter. At this writing, the government was in shut-down mode and Congress in early negotiations. To our minds, we expect the majority of legislators to be rational and reach compromise on the debt ceiling, though we remain perturbed that some political actors treat the full faith and credit of the U.S. as a bargaining chip. While we don’t think Congress will allow a default, the periodic inclination for politicians to push the nation to the brink justifiably troubles investors.
Returning to the long-term equity view, the investor wall-of-worry seems comparatively small now. With the Syria, Larry Summers, Fed tapering, Iran, Italian government, and other issues on the mend, sentiment isn’t as bearish as it was back in late August.
We continue to favor modestly the cyclical areas of the market, as we see the U.S. economy slowly improving. Earnings reports several weeks ago from two major home-builders confirmed that the U.S. housing market’s recovery troops along, with tight supply-demand conditions and rising prices. We think the wealth effect of housing strength should buoy confidence. Farther afield, some management teams of companies in the portfolio are even starting to talk about stabilization in the beleaguered European region.
Amid the equity market’s short-term preoccupations, we continue to hunt for those hard-to-find companies that earn high returns on capital with a record of deploying those returns profitably and in shareholder-friendly ways. We remind investors that we will adhere to our core investment tenets of company quality, solid business models, and attractive value. We think the portfolio remains attractively valued, though we are cognizant that some higher growth segments of the small-cap market appear somewhat generously valued. As we have said over the past few quarters, we believe there is a fair amount of pent up merger and acquisition demand in the small cap arena, and remain hopeful that the portfolio will catch its share as it unfolds.
Silvercrest Asset Management Group
New York, NY
As of September 30, 2013, Horace Mann Educators comprised 2.77% of the portfolio's assets, Lithia Motors – 2.36%, Portland General Electric – 1.75%, ICU Medical – 1.48%, and EnerNOC – 0.97%.
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.