1st Quarter 2013
The first quarter of 2013 was fantastic for domestic equity investors, with double-digit returns across all market-cap segments. Aggressive and unconventional monetary policy globally has led to the longest period of low interest rates in a generation. This has fueled a revival in the housing market and led to consumer sentiment hitting a four-year high.
As we mentioned in our third quarter 2012 commentary, the consumer is king and his home is his castle. A resurgent consumer economy provides a substantial foundation from which other sectors of the domestic economy can rebound. The rebirth of the U.S. oil and gas industry is revolutionary and its potential impact on the broader economy could rival that of the Internet during the 1990s. After a period of major investment in commodities over the last decade, inflation should remain subdued, allowing the consumer to continue to recover and maintain his standing in the royal court.
All sectors of the Fund’s Russell 1000 Index benchmark delivered positive returns during the first quarter, but three sectors within the Fund had negative total returns leading to a slight underperformance versus the index. Weak stock selection within Technology, Materials, Telecommunications, and Healthcare was the primary detractor from relative results. Within Technology, top-10 holding Apple had another disappointing quarter as the increasing threat from competing products continued to pressure the stock.
The Materials sector was hit hard by the sharp fall in commodity prices during the quarter, which negatively affected a number of mining stocks. Iron ore miner Cliff Natural Resources disappointed investors by drastically reducing its dividend. We sold the Fund’s position given management’s inability to execute its strategy. Royal Gold traded down in sympathy with the price of gold. We too sold this holding to fund better relative opportunities.
Other notable individual detractors included two consumer-oriented businesses with unique company-specific problems. Carnival reported strong quarterly results, but analysts lowered guidance on the stock to reflect weaker ticket pricing and greater ship repair costs. Investor sentiment towards the company was also hurt by recent negative publicity. United Natural Foods’ financial results were negatively affected by one-time charges caused by labor disputes.
Stock selection in the Financials and Energy sectors boosted relative performance, aided by an underweight stake in the lagging Technology area. Energy companies Phillips 66 and Range Resources were the portfolio’s top two performers during the quarter. Phillips 66 posted better-than-expected profitability from refining even as it expanded its pipeline business. Independent natural gas company Range Resources has shown better execution than its peers in increasing reserve replacement and boosting profitability from existing wells.
Chicago Bridge & Iron, Walgreen, and Athenahealth rounded out the top-five performers for the quarter. Chicago B&I increased clarity around its acquisition of Shaw Group, and how the combined company will grow profits above initial expectations. Walgreen reported better-than-expected quarterly results and an alliance with AmerisourceBergen. We think the Athenahealth acquisition of Epocrates significantly expands the cross selling opportunities for the firm’s health IT services.
The two notable adjustments to the portfolio during the quarter on a sector level were an increase in Financials and a in Materials. Financials, Consumer Discretionary, and Healthcare remained the three largest sectors in the Fund, with Financials taking the lead from Consumer Discretionary. Most of the changes occurred at the stock level, where we finished building positions in five companies.
Of these five new full positions, three stocks fit into our Leaders investment category. Here we look for best-in-class companies where a near-term issue has created a buying opportunity through a lower valuation. We introduced two Leaders within Financials— Arkansas-based Bank of the Ozarks and real estate investment trust (REIT) Redwood Trust. Bank of the Ozarks has been building market share both organically and via acquisitions, having consistently grown earnings and its dividend over the long term by lending conservatively to residential and commercial borrowers. Redwood Trust focuses on buying residential mortgage securities and providing financing to commercial properties via subordinated mortgages. It stands to benefit from any rebound in real estate and demand for mortgage-backed securities. The Fund also completed building a position in American Tower, a telecommunications Leader. Classified as a Financials stock in the benchmark because of its recent conversion to a REIT, American Tower owns and leases antenna space to wireless voice and data providers globally. We believe the company will continue to benefit as wireless carriers roll out advanced networks and services.
One new investment we classify as an Innovator, a company that has a history of introducing new products or services. Specialized semiconductor company Microchip Technology targets a wide range of end user electronic applications. We see the increasing influence of embedded chips in everyday products and think the company can benefit from this trend.
Lastly, we identified one new position that meets the criteria of our Laggard investment category. Although Laggards are typically under a cloud in having failed to deliver shareholder value relative to their competition, we believe these companies have the potential for significant gains in profitability as new or reinvigorated management teams seek to restructure operations. Technology company Yahoo! fits this description. We believe the new management team headed by Marissa Mayer from Google should provide leadership and more focused development to this digital media company.
Three full positions were sold during the first quarter, in addition to previously mentioned Cliffs Natural Resources and Royal Gold. Valuation and a more rigorous regulatory environment was the reason for the exit from Philip Morris International. Changing dynamics within the natural gas industry that could negatively affect long-term fundamentals led to the sale of Southwestern Energy. Finally, execution was disappointing at Teva Pharmaceutical Industries.
Overall, we remain constructive on the domestic economy and expect the rest of the world to catch up. We think this is an attractive environment for equity investments and while sparks and flares will keep us ever vigilant, we remain focused on the positive longer-term trend.
TAMRO Capital Partners
As of March 31, 2013, Apple comprised 2.98% of the portfolio's assets, Cliffs Natural Resources – 0.00%, Royal Gold – 0.00%, Carnival – 1.64%, United Natural Foods – 1.72%, Phillips 66 – 2.43%, Range Resources – 2.31%, Chicago Bridge & Iron – 2.08%, Walgreen – 2.03%, Athenahealth – 1.93%, Bank of the Ozarks – 1.42%, Redwood Trust – 1.36%, American Tower – 1.64%, Microship Technology – 1.44%, and Yahoo! – 0.77%.
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.