3rd Quarter 2012
Despite a solid rally that began in late July, mostly on the heels of comments from the president of the European Central Bank (ECB) that the bank would provide whatever liquidity needed to save the EU, many investors remain fixated on the macroeconomic problems in Europe, the looming “fiscal cliff” here in the U.S., and the upcoming U.S. elections. Although the market has shown remarkable resiliency, the problems facing global economies are very real. The market is a tremendous discounting mechanism that we think is coming around to the fact that with government spending beyond its means and the Federal Reserve largely out of monetary “bullets”, we are now in desperate need for fiscal reform to fix the damage that both parties in Congress have heaped on the American people and its economic system.
What would this mean for markets? More certainty about taxes, regulations and spending that could translate into multiple expansion for equities. We think it would lower correlations between stocks and dramatically reduce the market’s dependency on macroeconomic events, allowing for more emphasis on company fundamentals. Until that happens, however, markets are likely to continue to be driven by volatile macroeconomic events.
The Fund underperformed its Russell 2000 Growth Index benchmark during the quarter, with holdings in the Industrials, Healthcare, and Technology sectors the primary detractors to relative returns. Two construction and infrastructure companies, Dycom and Mistras Group, lagged within Industrials as telecom spending has fallen off during the back half of the year. We sold Dycom, but the portfolio still holds Mistras.
A few of the Fund’s holdings in Healthcare were hurt by several short-sale stories circling around the specialty pharmaceutical industry. Vivus, received approval for its weight loss drug Qsymia, a combination of two already approved compounds, but the stock sold off almost immediately on fears that physicians might substitute those two generic compounds for Qsymia. We understood the risk, but felt that the sell-off was an overreaction. Questcor dropped on rumors that generic competition from a European compound might threaten the position of its Achtar drug, used as the last line of defense in some debilitating diseases. We trimmed back on the portfolio’s sizeable stake in the face of this news, and then sold the position immediately when a major health insurer decided not to reimburse for the treatment, limiting further losses.
Finally, performance in Technology was just not good. This area has been void of a theme all year, but our stock picking has been off as well. Positions in software companies Service Source International and Tangoe caused most of the damage. Service Source reported an inline quarter, but was punished by some investors for how it recognized revenue. Tangoe was subject to online accusations of potential fraud that we take issue with but which crushed the stock nevertheless.
On the positive side, holdings in consumer-oriented areas and Financials outperformed. All five of the Fund’s holdings in Consumer Staples, including Schiff Nutrition, Elizabeth Arden, and Natural Grocers By Vitamin Cottage were off the charts relative to the benchmark. Homebuilders Ryland and MDC Corp. boosted returns within a strong Consumer Discretionary group. Financials were led by holdings in regional bank Banner and private equity firm Apollo Global Management.
As the market digests its move off the bottom from the correction of late spring and early summer, we truly believe that the “pain trade” is to the upside as lagging hedge funds feel compelled to play catch up. Thus, we think managers will run after stocks that have worked thus far, namely in the Consumer, Healthcare, and Financials sectors.
B. Anthony Weber Charles F. Mercer, Jr. CFA Michael E. Johnson, CFA
October 12, 2012
As of September 30, 2012, Mistras Group comprised 1.09% of the portfolio's assets, Vivus – 1.13%, Service Source International – 0.00%, Tangoe – 1.08%, Schiff Nutrition International – 1.29%, Elizabeth Arden – 2.51%, Natural Grocers By Vitamin Cottage – 1.83%, Banner – 1.23%, and Apollo Global Management – 1.38%.
Note: Small-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.