3rd Quarter 2011 Commentary - ASTON/Fairpointe Mid Cap Fund
3rd Quarter Commentary
It was a tough third quarter of 2011 for the Fund, which lagged its S&P Midcap 400 Index benchmark by more than three percentage points in delivering double-digit losses. U.S. equity markets were extremely volatile during the period, making it a difficult environment for fundamental stock pickers. The bulk of the negative absolute returns in the market, and the portfolio, occurred during a 30-day period from July 8 to August 8.
Winners and Losers
Three stocks dropped more than 30% during the quarter, hurting both relative and absolute returns. The outlook at leading Internet infrastructure and software provider Akamai Technologies remained softer than previously expected due to a weak pricing environment, sparking a sell-off in the stock. We added to the position on the weakness as we consider this a temporary pullback given the company’s ability to benefit from Internet traffic growth through streaming video. The company is debt-free and trading at a price/earnings ratio half that of its five-year average. The stock was the Fund’s top performer in 2010.
Itron is a global utility metering company that offers smart grid, distribution, and payment solutions to gas, water, and electric utilities, and was a recent addition to the portfolio. The firm is expected to benefit from increasing requirements to monitor and conserve the use of electricity, gas, and water. After losing ground to its competition, however, the Board of Directors replaced its CEO with the prior CEO and architect of the company’s products. Lastly, New York Times Company declined on continued weakness in advertising spending. We believe the stock remains undervalued given the company’s superior brand as a worldwide content provider.
Top individual contributors to performance during the quarter included Scholastic Corporation, Northern Trust, and Nuance Communications. The first two holdings actually delivered positive absolute returns amid the broad market sell-off. Scholastic is a global publishing, education, and media company that announced better-than-expected earnings. Higher sales of educational products and services to schools as well as higher sales of children's books in its retail channels contributed to the strong results.
We added new holding Northern Trust, a leading provider of custodial and advisory financial services, to the portfolio following the market decline in late July and early August. It benefitted from the timing of the purchase as the market and the stock was relatively flat, albeit choppy, through the end of the quarter. Leading provider of speech recognition and imaging technologies Nuance reported solid results in August, beating estimates and raising its guidance.
We took advantage of short-term price fluctuations during the quarter to rebalance positions— trimming stocks with higher valuations and adding to more attractively-valued stocks—and to purchase two new positions in CA, Inc. and the previously mentioned Northern Trust.
CA is an enterprise-level IT management software and solutions company providing products and services—from mainframe computers to virtualization to cloud-based services. The stock currently trades near the low end of its historical price/earnings to long-term growth rate (PEG ratio) and has an attractive dividend yield. We believe Northern Trust is a conservative franchise with a strong management team, an attractive business mix (37% foreign revenue), and the highest operating margins among its trust bank peers. Its stock is trading near the five-year low of its historical price/earnings ratio, with a low PEG ratio and solid dividend yield.
Much of the recent day-to-day market volatility has been driven by various global macroeconomic concerns: fears of a global recession, European sovereign debt issues, the economic policy stalemate in Washington D.C., and Standard & Poor’s downgrade of the creditworthiness of the United States. Despite all of this, the economic data for September was actually positive.
We believe that many of the macro issues have already been discounted by the U.S. stock market. Most U.S. companies are in better financial health today than they were in 2008. During the second quarter earnings season, two-thirds of the portfolio’s holdings met or beat consensus earnings expectations and another two-thirds of the holdings have recently announced significant share repurchase programs. These actions signal that these companies consider their shares undervalued, a view we share.
All told, the portfolio is trading at an average multiple based on 2012 consensus earnings estimates that is below the Fund’s benchmark and that of the broader market (as measured by the S&P 500 Index). Moreover, the portfolio’s PEG ratio proxy of valuation to growth has been this low only twice before during the 12 years we have managed the Fund—October 2002 and October 2008.
Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager
As of September 30, 2011, Akamai Technologies comprised 3.18% of the portfolio’s assets, Itron – 2.56%, New York Times Company – 3.06%, Scholastic – 1.71%, Northern Trust – 1.54%, Nuance – 3.34%, and CA – 1.71%.
Note: Mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.