2nd Quarter 2014
The second quarter was yet another in which low-quality issues led the way. According to Bank of America/Merrill Lynch research, the top performing groups within the Russell Midcap Growth Index for the quarter were companies without earnings, those with return on equity in the lowest quintile, and shares with the most volatility (high-beta stocks). A surprising drop in the 10-year U.S. Treasury bond yield in the face of rebounding economic data following the weather-impacted first quarter, additional liquidity measures by the European Central Bank, and dovish commentary from Federal Reserve Chairwoman Janet Yellen seemed to give investors the all clear signal to step back out on the risk curve and chase high-beta stocks once again. While we think this is getting to be a tiresome playbook for sure, we remain steadfast in our belief that our discipline and focus on quality, valuation, and earnings growth will serve shareholders well once stock prices begin to reflect the underlying fundamentals.
The Fund underperformed the Russell Midcap Growth Index benchmark during the second quarter. Overweight allocations to the Consumer Discretionary and Information Technology sectors, two of the weakest performing sectors in the benchmark during the quarter, negatively impacted the Fund’s relative performance. However, stock selection proved to be a bigger drag on results.
The Fund’s stock selection in Industrials, Financials, Information Technology, and Consumer Discretionary detracted. Within the Industrials sector, Jacobs Engineering Group was down during the quarter after a weak earnings report. While the company’s core business continues to do well, it is taking write-downs related to European projects and the acquisition of SKM, which closed at the end of 2013. These write-downs push out the improvement in earnings growth to fiscal 2015. As a result, we reduced the position. Within the Financials sector, Raymond James Financial sold off on a mixed quarter of in-line revenues but poor expense management, driving an earnings shortfall that we believe, is transitory. Within the Information Technology sector, Teradata and Xilinx detracted from performance. Teradata was down this quarter and we sold the portfolio’s remaining position after the company reported first quarter earnings that beat expectations but lowered full year guidance. Xilinx delivered below consensus revenue guidance for the June quarter after high expectations following the March quarter beat. Within the Consumer Discretionary sector, we eliminated the Fund’s position in Dick’s Sporting Goods. While the stock had recovered some of the losses following a reduction in second quarter earnings guidance related to weakness in golf and hunting, we exited the position due to a lack of earnings momentum.
Individual stocks that helped boost results included Robert Half, FactSet Research, WEX Inc., and IDEXX Laboratories. Robert Half was up during the period, led by improving staffing demand and strong growth in technology and risk consulting services. Shares of FactSet Research Systems increased as most of the company’s key operating metrics inflected positively, boosting confidence that revenue and earnings growth should reaccelerate over the coming six to 12 months. WEX Inc. also performed well during the quarter after beating consensus earnings estimates and raising revenue and earnings per share guidance. IDEXX Laboratories was up on a good earnings report based on slightly better gross margins and organic top-line growth. As a result of the strong quarter, we reduced our position as the stock was trading in excess of our estimate of fair value. Robert Half and IDEXX appreciated to levels above our estimate of fair value, leading us to reduce the size of those positions during the quarter.
New additions to the portfolio during the quarter included industrial parts supplier, Fastenal, and pharmaceutical wholesale distributor, AmerisourceBergen Corp. Fastenal is a name we have owned before in the portfolio with good success. Following two years of sideways action for the shares, Fastenal now appears poised to potentially resume its climb as revenue and earnings momentum reaccelerate, in our opinion. The earnings prospects for AmerisourceBergen look attractive, in our view, especially as the company gains increased scale and purchasing power from its alliance with Walgreens and Alliance Boots.
A moderate but synchronized global economic recovery and accommodative Central Bank policies throughout the developed world continue to be supportive of higher share prices. While the Federal Reserve has reduced its bond buying program, it still has been providing sufficient financial liquidity to help support higher share prices and contribute to very low levels of volatility in the stock market. While the longer-term outlook for the stock market, in our view, remains favorable, with recession risk low and corporate profits likely to hold up, the intermediate term outlook is more uncertain. Valuation and sentiment data are stretched enough now to suggest that investors are taking too much short-term risk for too little reward. Even though the Fed’s Quantitative Easing program could inflate asset prices further before it comes to an end this fall, any further increase in share prices will only increase stock market risk, as investors are likely to be left with inflated asset prices and unattainable fundamentals.
We continue to emphasize high-quality mid-cap companies with sustainable growth and return characteristics trading at reasonable valuations. We believe this approach is the prudent way to add value over the course of a full market cycle.
M. Scott Thompson, CFA
Andrew W. Jung, CFA
Jeffrey Wilson, CFA
As of June 30, 2014, Jacobs Engineering Group comprised 1.19% of the portfolio’s assets, Raymond James Financial – 2.26%, Xilinx – 1.99%, Robert Half – 2.14%, FactSet Research – 2.67%, WEX Inc. – 2.84%, IDEXX Laboratories – 1.47%, Fastenal – 1.99%, and AmerisourceBergen – 1.59%.
Note: Small- and mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
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.