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Oct 16 2012

3rd Quarter 2012 Commentary - ASTON/Lake Partners LASSO Alternatives

3rd Quarter 2012

Rebound Amid the Wobbles

In stark contrast to the second quarter, when the broad market S&P 500 Index dropped several percentage points, the market rebounded strongly during the third quarter. Ironically, the S&P 500 actually spent much of the quarter slipping sideways or dribbling downwards. The market’s overall rise was largely attributable to three quick bursts: the S&P 500 jumped 2.7% over three trading days in early August; 2.1% on the 6th of September; and then 1.6% on the 13th of September. Significantly, these rallies were sparked by political or policy developments. A look at the month-by-month sequence of events illustrates just how sensitive equity markets were to policy issues.

The S&P 500 wobbled back and forth between positive and negative territory for most of July. By mid-month, the index was down nearly 2% as the lack of detail from European policymakers and signs of deterioration in global manufacturing disappointed investors. A five-day rally then ensued on speculation that central banks would provide additional stimulus. When relief did not materialize, and as Spanish bond yields rose to dangerous levels, the S&P 500 slumped again down to where the rally had started. On July 26, however, European Central Bank (ECB) President Draghi pledged to “do whatever it takes to preserve the euro zone,” sparking a global equity rally that lifted the S&P 500 3.6% in two days. Although the rally quickly petered out, it left the index up for the month.

The three-day rally in August reflected investors’ anticipation of renewed monetary stimulus from the ECB and the Fed, as well as speculation that China would take steps to spur its economy. Better-than-expected retail sales, housing starts and jobless claims in the U.S. also boosted stocks. The momentum dissipated, however, over the last half of the month as concrete measures by the central banks failed again to materialize and economic news soured. Most significantly, China reported that its exports and imports continued to decline.

Markets jumped on the September 6 when the ECB presented its plan for Outright Monetary Transactions (OMT) and potentially unlimited purchases of 1- to 3-year bonds of countries that agreed to “strict and effective conditionality” under the EFSF/ESM bailout programs. The S&P 500 rose again on September 13 when the Fed announced another round of quantitative easing (QE3)—an open-ended commitment to buy $40B of agency mortgage-backed securities a month until employment improves. The Fed also extended its plan to buy longer-term Treasuries under Operation Twist through 2015. All of this was exactly what investors wanted to hear. What they did not want to hear was news of weakness in the manufacturing sector not only in the U.S. but also in Europe and China. When they did hear that news during the second half of the month, the S&P fell once more.

Long-biased Leads the Way

The Fund slightly outperformed its HFRX Equity Hedge Index benchmark in gaining a little more than 2% during the third quarter. The portfolio’s long-biased and long/short equity-oriented allocations benefited the most from the stock market’s rise and contributed the bulk of the returns during the period. Those returns came even though one of the Fund’s core managers was well hedged. Global Hedged Equity allocations, though small, also contributed, depending on the degree to which they were hedged.

Credit-related strategies also did well as a group, though they had somewhat more muted returns. High-yield was particularly productive, as it tended to move in sympathy with the equity markets. Hedged Credit activity had mixed results, given the volatility in sovereign bond markets. Merger Arbitrage managers tended to produce relatively stable returns much of the quarter. A global slowdown in merger and acquisition (M&A) activity and modest spreads tended to limit gains, though managers continued to find investment opportunities.

The Fund’s sole Global Macro holding had a solid quarter despite a portfolio that included a number of eclectic or longer-term strategies that were uncorrelated with markets. In contrast, the allocation to Commodities did poorly as quantitative long/short strategies were either out-of-sync or whipsawed by trend reversals. Fortunately, the Fund’s allocation to commodities has been relatively small.

Positioning

Due to the ongoing potential for volatility in the financial markets, the relatively defensive stance of some of our core managers, and the continued inclusion of non-equity related strategies—Hedged Credit, Strategic Fixed Income, Global Macro, and Commodities—the Fund’s net equity exposure has remained in the 30% to 35% range. That is just below the midpoint of the 20% to 50% net equity exposure range that we target for the Fund.

The overall structure of the portfolio was largely stable throughout the quarter. Equity-oriented funds accounted for 48% of assets at the end of September, unchanged from June. Although this is the largest single strategy 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. We continue to focus our allocations on core managers with relatively stable risk/return characteristics.

The combined allocation to Hedged Credit and Strategic Fixed Income was also unchanged at 25% of assets. Hedged Credit has been a slightly larger allocation at 13%, reflecting improved valuations and solid fundamentals. The funds in Strategic Fixed Income tend to take a global approach, long and short, to a broad range of opportunities, ranging from US mortgage-backed securities to emerging market debt.

We reduced the allocation to Global Macro and Commodities from approximately 11% to 8.5% primarily from eliminating one underperforming fund whose quantitative approach had become out of sync with the market. The primary holding in this segment is to a global macro manager that uses a diverse set of quantitative and fundamental strategies across a wide range of asset classes.

Outlook

As noted in our previous commentary, the pendulum of investor sentiment has swung back and forth between two perspectives since the global credit crisis of 2008. The negative side has focused on the debt crisis in Europe, doubts about the resilience of China, and fears of tepid growth and policy paralysis in the US. The positive side has reflected strong corporate earnings, and efforts by central banks to provide stimulus. During the first quarter of this year, the positive side dominated. During the second quarter, the negative side prevailed. Since June, equity markets have been able to grind higher, albeit in fits and starts, as the prospect of stimulus once again trumped macroeconomic concerns.

Will the “pendulum” of market volatility continue to gyrate back and forth? On one hand, the policy and political issues that have dogged investors remain unresolved. On the other hand, Europe seems to be struggling towards finding a way to address its debt problems, even though financial union remains elusive. The prospect of fiscal retrenchment and political gridlock still hangs over the US, and the upcoming election is a wild card, though the Fed is determined to do its part to aid the economy. China’s economy continues to slow, but policymakers may be ready to step up their response, especially once it finalizes its leadership change.

Longer term, the outlook is relatively positive, as the global economy is expected to “muddle through” on the back of corporate cash flows, strong balance sheets in the U.S., and generally fair equity valuations. It is the near term that is challenging. We therefore are maintaining a diversified mix of strategies within the Fund, spread across equity-oriented, credit-oriented, arbitrage, global macro and long/short commodities, with different degrees of correlation and market sensitivity. We believe that this approach will allow the Fund to live up to its history of producing attractive risk-adjusted returns over time. 

Lake Partners, Inc.
Stamford, Connecticut

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.

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.

Resources

Aston History (228 KB, PDF)
Capabilities Brochure (4 MB, PDF)
Aston Style Box (41 KB, PDF)
Aston Subadvisers (436 KB, PDF)
Sales Map .pdf (2 MB, PDF)

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