3rd Quarter 2013 Commentary - ASTON/LMCG Small Cap Growth Fund
3rd Quarter 2013
A strong start to the summer and a strong finish lifted U.S. equities to healthy gains during the third quarter, pushing the year-to-date returns of most stock indices to more than 20% by the end of September. The Federal Reserve’s plans to taper its bond-buying program, whether interpreted to signal economic improvement or ongoing monetary support, generally set a positive backdrop for the market. Only the chemical weapons tragedy in Syria in August and the global debate over U.S. and other western involvement put a damper on performance. More recently, the partial government shutdown and the looming debt ceiling have brought renewed softness and concern as we move into October and the final quarter of 2013.
Stylistically and across market-caps, a separation seemed to begin during the third quarter with growth benchmarks far outpacing their value counterparts and small-caps well ahead of large-caps. Among small-caps, the Fund’s Russell 2000 Growth Index benchmark gained nearly 13%, outperforming the Russell 2000 Value Index by more than five percentage points. The growth-value differential was similar for mid-caps and large-caps, as investors appeared to have embraced the highest-earning growth companies across all segments. The Technology and Energy sectors were, as a result, among the strongest performing groups during the period. Financials and Utilities, on the other hand, were relatively weak.
The Fund participated in the strong absolute returns among small-growth stocks, but lagged the benchmark by a notable margin. The portfolio’s positioning in the Healthcare and Technology sectors accounted for the majority of the return shortfall during the quarter. The natural leveling or retracements among hospital holdings following sharp merger and acquisition related gains earlier in the summer detracted from returns within Healthcare. We think the inevitable shareholder challenges to the deals involving Vanguard Health Systems, Health Management Associates, and Community Health Systems will ultimately be resolved and that the merger synergies they create will translate to revenue and margin expansion for these companies in the future.
Two medical device makers with a focus in cardiology, Volcano Corp. and HeartWare International, also contributed meaningfully to performance within Healthcare, both positively and negatively. Volcano (outperformed) operates in the interventional cardiology space while the HeartWare (underperformed) device targets late-stage heart failure patients. Finally, shares of Merge Healthcare, a developer of medical image sharing software, declined after the company reported lower than expected revenues and earnings during the period.
Within Technology, key performance drivers included Internap Network Services and Vantiv on the negative side, and iGATE on the positive side. Internap shares traded lower this quarter, but we think this emerging IT infrastructure company offers meaningful growth potential through its co-location and managed hosting segments. iGATE is a specialized IT outsourcing company that we think should benefit from structural changes in the IT servicing industry. We remain confident in the key holdings in both Healthcare and Technology within the portfolio, and that the growth potential in these companies will be recognized going forward.
Elsewhere, the Fund also lagged in the Financials sector due primarily to three holdings organized as REITs (real estate investment trusts) or that are in the process of converting to a REIT structure. REITs as a group have suffered since interest rates began their rise following the Fed tapering announcement in May. The portfolio’s holdings in this group include private prison operator GEO Group, resort hotels operator Ryman Hospitality Properties, and data center operator CyrusOne.
On the positive side, stocks in the Consumer Discretionary sector, particularly select retailers OfficeMax and GNC, as well as Energy holdings were especially strong during the quarter. Investors seemed to have embraced OfficeMax’s announced combination with Office Depot, while vitamin/supplement retailer GNC’s shares have responded to strong revenue and comparable store sales numbers as well as new store openings globally. Energy stocks Magnum Hunter Resources and Gulfport Energy recorded strong third-quarter gains. Magnum Hunter is an exploration and production company, and production out of the Marcellus field in West Virginia has been particularly strong. Gulfport operates primarily along the Louisiana coast and in Ohio’s Utica Shale. The stock held up well even as the company reduced production guidance due to unexpected pipeline delays and downtime.
We seek to achieve competitive returns by identifying unrecognized growth potential across all industry sectors by identifying firms with high quality business models, distinct competitive advantages, proven management teams, and significant growth potential. Revenue growth, margin expansion, and the ability to positively surprise and revise estimates are key characteristics that we look for in holdings for the portfolio. We want these firms to have duration and sustainability of these characteristics based on their competitive positions in the industry. We think that the experience and focus of our investment team and their knowledge of key industry drivers can help us to achieve that goal.
Lee Munder Capital Group, LLC
As of September 30, 2013, Vanguard Health Systems comprised 2.55% of the portfolio's assets, Health Management Associates – 0.77%, Community Health Systems – 3.67%, Volcano – 1.57%, HeartWare International – 2.35%, Merge Healthcare – 1.45%, Internap Network Services – 3.28%, Vantiv – 3.43%, iGATE – 1.43%, Geo Group – 4.31%, Ryman Hospitality Properties – 1.37%, CyrusOne – 1.77%, OfficeMax – 2.23%, GNC – 1.70%, Magnum Hunter Resources – 1.33%, and Gulfport Energy – 1.20%.
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.