1st Quarter 2014
The Fund kept pace with its Russell 1000 Value Index for much of the quarter before succumbing to macroeconomic concerns the last two weeks of the period. The underperformance coincided with concerns regarding geopolitical conflict caused by the Russian military intervention into the Ukraine, generally, and Crimea, specifically. Although war has not broken out, the international community has predominantly come out against the moves Russia has made. Concerns for global stability and growth rattled markets. As a result, many of the portfolio’s holdings came up short of the broader benchmark.
Sector allocation and stock selection were both negative for the quarter, with the overwhelming detractor being sector allocation. The sectors with the lowest contribution were Healthcare, Consumer Staples, and Utilities. Although underweight the strong performing Healthcare sector, a great deal of the underperformance in the sector came from just one stock. United Therapeutics fell out of favor with the market despite improving fundamentals and strong gains in 2013, declining almost 17%. Following suit, an overweight stake in the lackluster Consumer Staples sector was dragged down by Herbalife, which became the subject of a Federal Trade Commission investigation. Although short-sellers have applauded the move, Herbalife has also championed the investigation as a chance to get the truth out about its business model. It is likely to be a lengthy process, however, and we exited the position.
Utilities, the poster child for defensive investing, gained almost 10% during the quarter. The Fund has been steadfastly underweight the sector on valuation concerns. In addition, the portfolio’s sole holding, AES, generated a slightly negative return for the period.
Elsewhere, asset manager Eaton Vance was a detractor from performance. The company has struggled with equity performance of late, plus it has exposure to the turbulent fixed-income markets. The sell-off in fixed-income has proved challenging to companies with more exposure to that area. To address issues with its equity strategies, the company hired a new Chief Investment Officer from Goldman Sachs.
An overweight stake and solid stock selection in Materials aided returns, along with stock picking in Industrials and Energy. Three out of portfolio’s four holdings in Materials delivered double-digit gains in outperforming the broader sector. The only laggard was Southern Copper, which has struggled on concerns about the supply and demand dynamics of copper. Portfolio holdings in Industrials posted modest positive returns versus a slight loss for the sector overall. Aerospace and defense companies such as Lockheed Martin and Rockwell Collins led the outperformance.
In similar fashion, the Fund’s Energy holdings rose against a slight decline in the benchmark sector. The portfolio benefited from a diversity of exposure to sub-industry holdings in lieu of concentrating on integrated international names. Among the individual standouts were Ultra Petroleum and Patterson-UTI Energy. Both benefitted from a strong rise in the price of natural gas amid the extremely challenging winter season, along with the possibility for an increase use of services—particularly for Patterson. Finally, Financials firm Waddell & Reed was another strong contributor, as it continued to post solid fundamentals and trade at an attractive valuation.
Buys and Sells
Stocks eliminated due to sector adjustments and/or valuation/fundamental issues were Endo Health Solutions, RPC, Patterson-UTI Energy, Landstar, and the previously mentioned Herbalife. These changes were primarily driven by the dynamic interrelationships of the sectors as we position the portfolio to exploit value creating opportunities. As we share regarding our investment philosophy, “We have a core process but no core holdings.”
We established positions in Neustar and ConocoPhillips during the quarter. Technology firm Neustar is a provider of IT security as well as real-time information and analysis using proprietary, hard-to-replicate data sets. ConocoPhillips is a giant energy conglomerate that, like each of our purchases and holdings, was identified as a value creating opportunity and vetted using fundamental analysis.
The result of this and related activity during the quarter was that the Fund increased its exposure to Financials, Energy, Consumer Discretionary, and Materials, while exposure to Consumer Staples, Healthcare, and Industrials declined. All other sectors essentially remained the same other than for market appreciation or depreciation.
Despite a choppy first quarter, returns were positive in the end. We were encouraged by the fact that until the latest crisis started, the Fund was quite competitive with its benchmark. We believe that short-term blips create opportunities that might take a while to be realized, and think the portfolio is in such a position. The Russia-Crimea situation notwithstanding, the overall economic picture is getting better here in the U.S. as well as around the world. It is likely to be yet another page in the long narrative that makes the stock market interesting.
Something interesting happening does not mean that there is a specific activity to undertake in response to what is happening. Although we follow and discuss issues that are timely and important, in our following and discussing we do not do so as an exercise in finding activity. Instead, we lean to our process.
As noted in past commentaries, our process is geared toward a long-term objective, similar to that faced by an endurance runner. Our investment journey is one that will often put us at odds with conventional thinking and wisdom in the near-term. Taking the opposite side has frequently proven to be quite profitable if prudently executed. It is this process that we execute on behalf of shareholders in the Fund.
This process has resulted in a portfolio that is overweight Energy, Materials, Technology, Consumer Staples, and Consumer Discretionary. We are underweight Financials, Health Care, Utilities, and Telecom while also being neutral in Industrials. Our allocation is based on a proprietary way of identifying value creating opportunities at the stock and sector level. Although it may not always yield immediate results, our success as a firm has shown that it can work with a long-term goal in mind.
As the market becomes less concerned about short-term macroeconomic issues, or “noise”, and focuses on the prospects of companies juxtaposed against their valuation, we believe the Fund has the potential to offer attractive returns.
Randell A. Cain, CFA
Principal and Portfolio Manager
Herndon Capital Management
As of March 31, 2014, United Therapeutics comprised 0.58% of the portfolio's assets, Herbalife – 0.00%, AES – 0.93%, Eaton Vance – 1.84%, Southern Copper – 0.38%, Lockheed Martin – 2.91%, Rockwell Collins – 1.91%, Ultra Petroleum – 2.16%, Patterson-UTI Energy – 0.00%, Waddell & Reed – 3.08%, Neustar – 0.95%, and ConocoPhillips – 1.03%.
Note: Value investing involves buying the stocks of companies that are currently out of favor and may decline further.
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.