4th Quarter 2012
The “risk on” trade prevailed within the Fund’s Russell 2000 Value Index benchmark during the fourth quarter, as higher beta (volatility) stocks and sectors outperformed. Higher-quality stock trends were more mixed, for both the quarter and the full year 2012, and certainly less favorable than the generally “high-quality” tailwind of 2011. On the sector level, Materials and Consumer Discretionary were among the top areas in the index during the quarter, delivering solid gains, while Healthcare and Utilities posted losses as the laggards.
The Fund slightly outperformed its benchmark during the quarter, but trailed it for the full year. Although we were disappointed to fall behind the index in the Fund’s first year, we were pleased to have generated double-digit returns for investors. Last year proved to be a difficult one for active managers in general, as an analysis by Bank of America/Merrill Lynch indicates that only 35% of small-cap value and 28% of small-core funds beat their benchmarks in 2012.
Overweight positions in Industrials and Materials aided performance during the quarter, while an overweight stake in Healthcare was the only meaningful sector allocation that detracted from relative performance. Stock selection in the portfolio outperformed in six sectors of the Russell sectors, with the best relative performance in Healthcare, led by Invacare. The Fund’s edge was fairly modest in most of the other outperforming sectors.
Although sector allocation and stock selection were both positive contributors for the quarter, they detracted from relative returns for the year. Poor stock selection in Financials and Materials overwhelmed generally positive results elsewhere.
We initiated five new holdings in the portfolio during the quarter—Lithia Motors, Fair Isaac, Chemtura, Entegris, and Steris. Oregon based Lithia is the ninth-largest auto dealer in the U.S., serving mostly smaller markets west of the Mississippi. In a rebounding auto market, we thought the shares were attractively valued relative to earnings estimates for the next 12 months. Although Fair Isaac is listed as a Financials stock, we think of it more as a technology company. With its omnipresent FICO score, it is the market leader in credit scoring and has been extending its franchise into decision management, fraud detection, and customer management for financial institutions. The company reports solid free cash flow and return-on-invested-capital metrics, and its stock was trading at an attractive valuation relative to double-digit long-term earnings per share growth marked by high recurring revenues.
Chemtura is a specialty chemical company in the midst of a restructuring that involves selling some of its lower margin businesses in an effort to attain some ambitious sales and earnings goals. Although we think the goals might be a bit too ambitious, particularly on the sales side, the company has been executing well of late and has made progress in its restructuring. If it gets just halfway toward its goals, we think that the stock would still represent an attractive value relative to its expected growth. The firm’s current CEO formerly managed Hercules (which was eventually sold to Ashland), and he may be repeating the same game plan with Chemtura.
Entegris is a manufacturer and supplier of products and services used to maintain the purity and integrity of critical materials in semiconductor and other high-technology manufacturing. Two-thirds of its business is consumables, including liquid and gas filters used in the semiconductor manufacturing process. The company is trading at a discount to our current estimated fair value. Entegris also possesses some appeal as a potential takeout candidate given its high market share in technology applications, which may look attractive to larger, more diversified filter manufacturers. Steris has improved its portfolio over the past couple of years and we think it is poised to show low double-digit earnings growth with solid cash generation that will enable shareholder-friendly capital allocations.
We eliminated two holdings from the portfolio during the quarter, Mistras Group and Thermon Group Holdings. Mistras was sold due to spotty execution and Thermon due to its reaching our fair valuation target. Both stocks were part of the overweight stake in Industrials, and the proceeds from the sales were redeployed to other areas.
Looking ahead, we are conscious that U.S. politicians averted the “Fiscal Cliff” from a tax perspective but still face formidable issues over the next few months related to the debt ceiling and sequestration of government spending. Both issues could have a significant impact on the economy if not resolved, and will certainly weigh on investor psychology in the near term. That said, we think the broader picture is attractive as we sense the U.S. economy is becoming relatively more competitive versus other nations. The company management teams of holdings in the portfolio are indicating, and recent news reports seem to confirm, a trend toward more U.S. manufacturing. As such, we think the U.S. equity market presents some exciting opportunities.
From a thematic perspective, we continue to favor economically sensitive areas of the market, since the macroeconomic environment is grudgingly getting better. Several industries look geared for recovery, including autos and housing, as they are likely to benefit from pent-up demand. While we are unlikely to own such cyclical and capital-intensive businesses as homebuilders, automakers, or airlines directly, we’ll look for derivative equity investments that benefit from the same trends.
We are also pleased to note that after a lengthy acquisition drought one of the portfolio holdings, Duff & Phelps, become the object of takeover interest on the last day of the year. The company announced that it had agreed to be acquired by a private equity consortium. We believe there is significant pent up demand for merger and acquisition activity in the small-cap space, and with the recent partial resolution of the “Fiscal Cliff”, we may at last have a catalyst to get things rolling. Overall, we sense modest optimism from management teams of holdings in the Fund for 2013, and we find the portfolio itself attractively valued.
Silvercrest Asset Management Group
New York, NY
As of December 31, 2012, Invacare comprised 0.89% of the portfolio's assets, Lithia Motors – 1.69%, Fair Isaac – 1.67%, Chemtura – 1.62%, Entegris – 1.28%, Steris – 1.23%, and Duff & Phelps – 1.95%.
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.