3rd Quarter 2010 Commentary - ASTON/Lake Partners LASSO Alternatives Fund
3rd Quarter 2010 Commentary
More Market Volatility
At the beginning of the third quarter, we wrote that "The last decade began with much discussion about 'irrational exuberance.' Recent market action [note: the S&P 500 Index had just finished dropping 11.4% during the second quarter] may justify a certain degree of uncertainty among investors, but perhaps we will look back at the current period as one of 'irrational pessimism.' We continue to position LASSO to dampen the risk of conventional asset classes, but we are poised to make strategic allocations as opportunities arise."
Well, market volatility certainly did create such opportunities during the third quarter. While the S&P 500 chalked up a stunning return of 11.3% during the quarter, it was very much a roller coaster ride along the way—subjecting investors to scary plunges and thrilling rises. Volatility has been quite pronounced since the beginning of the year, but the up and down swings in the index were especially wide during the third quarter. From June 30 through August 9 (the interim market peak), it gained 9.6%, with only minor, short-term corrections. The index then plunged 7.0% before bottoming out on August 26. From that point through the end of September, it shot up 9.2%, almost without interruption. Furthermore, volatility was high not only in equities but also in fixed-income, credit, currencies and commodities. As a result, there were strategic opportunities in a variety of areas.
We have been proactive all year in making pragmatic adjustments to LASSO's mix of strategies. We continued this process during the quarter, but with more of an incremental approach given the high degree of market volatility. First, we slowly increased long-biased equity, which served the Fund well as the market rebounded. Second, after credit spreads widened we trimmed the portfolio's allocation to the strategic fixed-income area in favor of hedged credit—a productive shift as market conditions subsequently improved. Third, merger arbitrage allocations were reduced during the quarter from 15.2% to 11%. Although M&A activity picked up, spreads have not been particularly generous. Finally, we initiated a 4% allocation to long/short futures and currencies programs at mid-quarter in order to enhance diversification.
Volatility Creates Opportunities
During the quarter, the Fund generated a solid gain that matched the performance of its HFRX Equity Hedge Index benchmark. Long-biased hedged equity allocations represented the largest contribution to returns, which is not surprising given the overall rise in equity markets. Holdings of managers that had an orientation towards growth and small-cap stocks did especially well. Relatively hedged long/short strategies also participated in the market's upside, though to a somewhat lesser degree depending on their net equity exposure.
Credit related strategies also added value, especially as market conditions improved and spreads steadily narrowed. These strategies also tended to have more stable risk/return characteristics. Strategic fixed-income allocations served the Fund well as a source of diversification, but as a group returns were fairly muted. Some of the managers the portfolio owns in this group have tended to be defensive. A small position in an interest-rate hedge (short US Treasuries) corrected as yields trended lower. We have maintained the position due to long-term concerns associated with massive government debt issuance and deficits. Merger arbitrage returns were positive but modest. As noted above, this allocation was reduced.
Throughout the year we have positioned LASSO to dampen the risk of conventional asset classes while maintaining the potential for relatively consistent returns via alternative strategies. As a result, the portfolio's net equity exposure has generally been relatively conservative. Nevertheless, we increased equity exposure at the margin in recent months, which provided a substantial payoff in September. More importantly, because we expect volatility to be a feature of the investment landscape for the foreseeable future, we have remained focused on further diversifying the mix of strategies within the portfolio.
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 includes 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.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.
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