4th Quarter 2013 Commentary - ASTON/Lake Partners LASSO Alternatives
4th Quarter 2013
U.S. equity markets enjoyed a remarkably strong run for much of the fourth quarter. Although the period began on a down note as the imbroglio over the budget and debt ceiling intensified, the correction was limited and short-lived. As soon as Congress and the White House forged an agreement to reopen the government and extend the debt ceiling, at least temporarily, stocks began to rally. Added impetus came from indications of softness in a jobs report, supporting speculation that the Federal Reserve would continue to put off any “tapering”, and further boosted by the nomination of Janet Yellen to head the Fed.
The rally stalled somewhat by mid-November, but stocks finished December strong after investors responded positively to Fed Chairman Bernanke’s announcement that tapering would indeed get underway, but with only a modest reduction of asset purchases. Bernanke also made it clear that short-term interest rates would remain low for an extended period. Positive sentiment was reinforced by news that U.S. Gross Domestic Product grew at a 4.1% annualized rate during the third quarter.
In fixed income, high-yield bond indices continued to advance and emerging market debt delivered modest upside, while core and peripheral sovereign bonds in Europe were stable. In contrast, US Treasuries faced ongoing pressure. Notably, the yield on 10-year Treasuries climbed steadily from 2.6% at the end of September to 3.0% at the end of December. Although the Barclays US Aggregate Bond Index was off only 0.1% for the quarter, 7-to-10-year Treasuries lost 2.0%.
The Fund posted solid gains during the fourth quarter, but trailed its HFRX Equity Hedged Index benchmark during the period, and for all of 2013. It fared significantly better against its peer group in outperforming during the quarter, and substantially bested its peers in 2013.
Collectively, equity-oriented allocations accounted for the bulk of the Fund’s return during the quarter. Returns for the underlying funds tended to vary with their degree of net equity exposure. Nevertheless, all but one of the portfolio’s allocations had solid gains. The one exception was a long/short Emerging Markets manager. This fund was sold early in the quarter and had been a relatively small allocation, so its effect was minimal.
Hedged Credit and Strategic Fixed Income strategies produced relatively stable gains, with corporate credit exposures being the leading source of returns. A Merger Arbitrage manager was up marginally for the quarter, as corporate events were more relevant to the portfolio than market action. The portfolio’s Convertible Arbitrage manager was much more productive due to higher residual equity exposure. Nevertheless, the fund maintained a relatively stable risk/return profile for much of the quarter.
The Fund’s sole Global Macro strategy generated a solid gain. Its portfolio of diversified and eclectic sub-strategies, which cover multiple asset classes, made steady progress throughout the period.
Due to the ongoing potential for renewed volatility in financial markets, we maintained the Fund’s net long equity exposure at approximately 30% during the quarter (well within its guideline range of 20% to 50%). 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 adjusted marginally over the course of the period. The core of the portfolio continued to be represented by a diverse set of equity-oriented allocations, accounting for 58% of assets at year-end. This was an increase from the 52.5% at the end of September. We established, and then increased, an allocation to a highly hedged global manager, while eliminating the previously noted long/short Emerging Markets manager. We also increased the allocation to a large-cap “blend” “130/30” quantitative manager. Although equity-oriented strategies represent the largest single 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.
The combined allocation to Hedged Credit and Strategic Fixed Income strategies continued to be scaled back, to 20% at year end from 23% at the end of September (at the end of March the allocation had been 32.5%). We increased the allocation to a credit manager, while eliminating a high yield manager and an income-oriented fund, and trimming a global long/short credit manager.
The allocation for Global Macro was trimmed from 5% to 3.5%. The portfolio’s position continues to be represented by a global macro manager that uses a diverse set of quantitative and fundamental strategies across a wide range of asset classes. We have continued to avoid long/short commodities and trend-following strategies, as many of the funds in these areas have been out-of-sync with the markets.
For much of 2013, market trends clearly demonstrated liquidity and momentum can have the power to energize investors. As uncertainty about tapering and the US budget/debt ceiling dissipated, volatility in equity markets, as measured by the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), diminished to levels not seen since before the global financial crisis. The few spikes that did occur were relatively limited and brief.
Underpinning the general uptrend for equities was the fact that the central banks of developed economies played their cards well. Quantitative easing and accommodation trumped fiscal constraints and slow progress on structural reform, not only in the U.S. but also in Europe and Japan. Struggles over political and policy issues, however, especially in Washington, were directly responsible for touching off corrections in equity and fixed-income markets. Going forward, dysfunctional governance and policy missteps will remain significant risks for financial markets.
Longer term, the outlook is relatively positive, as the global economy is expected to “muddle through,” as corporate cash flows and balance sheets in the U.S. are strong, and equity valuations generally are fair (although they are becoming richer). In the near term, though, market trends remain subject to policy and political uncertainties. Furthermore, investors will be sensitive to economic headlines that do not validate expectations of improving global economic growth. Consequently, renewed bouts of volatility would not be surprising. 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 live up to its history of producing attractive risk-adjusted returns.
Lake Partners, Inc.
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.