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Apr 19 2013

1st Quarter 2013 Commentary - ASTON/TAMRO Small Cap Fund

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. 

Slight Underperformance
All sectors of the Fund’s Russell 2000 Index benchmark, and all but one of the sectors in the portfolio delivered positive returns during the first quarter as the Fund slightly underperformed the benchmark. Holdings in the Consumer Discretionary, Consumer Staples and Energy delivered relatively weak performance, with an overweight position in the strong Consumer Staples area also hurting relative returns.

The Fresh Market, Chico’s FAS, and United Natural Foods were among the notable individual detractors during the quarter. Fresh Market announced disappointing same-store sales growth and weaker than expected guidance, contributing to a sell-off in the stock. We eventually sold the full position as the competitive landscape was becoming more of a headwind for the company. Organic revenue growth was lower than expected for specialty apparel retailer Chico’s, and management provided cautious guidance. United Natural Foods’ financial results were negatively affected by one-time charges caused by labor disputes.

Although an underweight position in suffering Materials stocks aided relative results, most of the standout performers in the portfolio came from the Financials, Technology, and Healthcare sectors. In Financials, top-holding Bank of the Ozarks reported strong quarterly results and the acquisition of another regional bank on the open market, while real estate investment trust (REIT) Redwood Trust moved higher on the announcement of an increase in the company’s quarterly dividend. Rural hospital operator Health Management Associates reported results in-line with expectations, but investors seemed to show enthusiasm for the company’s prospects under healthcare reform. Finally, telecom provider Acme Packet agreed to be acquired by Oracle, surging more than 20%. 

Portfolio Positioning
There were no major adjustments at the sector level during the quarter, as Financials, Consumer Discretionary, and Healthcare remained the three largest sectors in the Fund. Most of the changes to the portfolio occurred at the stock level. Typically, we only report on new investments after we have completed building a full position in the Fund. Thus, most of the stocks discussed below were initiated prior to the first quarter, and only reached full position status through appreciation or additional buys this year.

Of the eleven new full positions, six 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. Tootsie Roll and Sanderson Farms, both Consumer Staples companies, met this criteria as high ingredient costs temporarily pressured operating margins at the food companies. Industrials firms Raven Industries and Landstar System, and Energy holding Lufkin Industries also suffered what we consider temporary setbacks. Each suffered weak revenue growth due to the slowdown in global economies, but we anticipate that conditions will improve. Lastly, leading pawn-shop operator First Cash Financial is showing a clear expansion in profitable growth that we believe is not reflected in its valuation.

Four of the new investments we classify as Innovators, companies that have a history of introducing new products or services. Three Technology firms—Cavium, Cirrus Logic, and Power Integration—touch on the major trends of mobility, cloud computing, and energy efficiency. Meanwhile, Tempur-Pedic International is a company that has found a novel way to build a mattress that relieves pressure, with the goal of improving the quality of sleep.

Lastly, we identified one new position that meets the criteria of our Laggard investment category. Although Laggards are typically under a cloud 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. A new management team at Consumer Staples firm Cott Corp. is effectively boosting profitability of this private label and contract manufacturer of beverages by instituting more operational controls and identifying higher margin product initiatives.

Four full positions were sold during the first quarter, in addition to the previously mentioned Acme Packet and The Fresh Market. We parted company with long-time holding Chicago Bridge & Iron after it surpassed $5 billion in market cap, growing out of the market-cap range for the Fund.

Unfortunately, increased uncertainty surrounding the ability to execute led to the sale of the other three stocks. Energy exploration and production company Comstock has been affected by the glut of natural gas that has depressed the price of the commodity. We prefer to focus on the beneficiaries of the depressed pricing rather than the producers. Iberiabank was used as a source of funds for new opportunities due to our growing uncertainty regarding management’s plan to boost profitability. On-line realty site Zillow was sold due to poor visibility of operating trends for the company.

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

Alexandria, Virginia

As of March 31, 2013, The Fresh Market comprised 0.00% of the portfolio's assets, Chico’s FAS – 1.73%, United Natural Foods – 1.96%, Bank of the Ozarks – 2.81%, Redwood Trust – 2.76%, Health Management Associates – 2.20%, Acme Packet – 0.00%, Tootsie Roll – 1.25%, Sanderson Farms – 1.49%, Raven Industries – 0.51%, Landstar System – 1.89%, Lufkin Industries – 1.70%, First Cash Financial –  1.78%, Cavium – 1.83%, Cirrus Logic – 1.42%, Power Integration – 1.43%, Tempur-Pedic International – 2.08%, and Cott Corp. – 1.57%.

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.


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