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Jul 15 2013

2nd Quarter 2013 Commentary - ASTON/Fairpointe Mid Cap Fund

2nd Quarter 2013 

Following a strong first quarter, U.S. stocks were again in positive territory for the second quarter of 2013 as the relative strength and stability of the U.S. economy continued to attract investors. Mid-cap stocks slightly underperformed large- and small-cap stocks in general, though returns varied widely among index providers. Although the Russell MidCap Index was up 2.2%, the Fund’s S&P MidCap 400 Index benchmark lagged more sharply in gaining only 1% during the period. 

Broad Outperformance
Regardless, the Fund bested all the broad market indexes by a wide margin during the quarter, further boosting its overall outperformance for the year-to-date through the end of June. The positive performance was broad-based, with 19 stocks up more than 10% and only one stock down more than 10%. The top contributor to performance was First Solar, a leading supplier of solar energy systems and solar panels. Investors are increasingly recognizing what we see as the company’s solid financial position—enhanced by its recent stock offering—competitive technology, and a book of business to carry it through an industry slowdown.

Top-holding Boston Scientific was another positive contributor as the company continued to benefit from shifting investor sentiment. The market is recognizing the quality of the firm’s product pipeline as pricing pressure in its core cardiovascular businesses moderates. Following two consecutive strong quarters, the stock is up 62% since the beginning of the year. Long-time holding Akamai Technologies was another top performer after announcing first quarter results that were better than expected, helping to calm investor concerns about increasing product development and sales/marketing expenditures.

Notable detractors from performance included McDermott International, Nuance Communications, and Itron. McDermott is a global engineering and construction company serving the offshore oil and gas market that dropped more than 25% during the quarter. With the stock trading just above book value, we took the opportunity to add to the position as we believe the company will rebound as it addresses recent execution issues. Nuance declined after the company lowered guidance. With expectations lowered, its cost structure being addressed, and the stock trading at a discount to historical valuations, we think further downside is limited and added to the position.

Metering solutions company Itron sold off after reporting a disappointing quarter attributed to weak bookings and lower margins. The company is poised to benefit as large projects come to market over the next 12 to 18 months. Current estimates show that only 12% of utilities worldwide are automated, and we expect Itron will be a beneficiary of increasing meter automation. We also added to this position during the quarter. 

Buys and Sells
We established a position in Juniper Networks, a leading supplier of high-performance network/infrastructure equipment and solutions, in the portfolio during the quarter. We think the company is well positioned to benefit from an improved telecom capital expenditure environment as well as the continued growth of Internet traffic.

We sold Chicago Bridge & Iron, a long-term holding, after the company acquired Shaw Group –almost doubling its size. We were concerned that this transformative acquisition could result in integration problems, operational issues, and earnings dilution. The stock had significantly increased in value during the Fund’s holding period. Mattel was another successful long-time holding sold after the stock met our price objectives.

We continue to trim positions when stock valuations are high and add to positions with sound fundamentals and more-attractive valuations. With the market move we have seen thus far in 2013, we believe that stock selection has again become very important. We intend to remain focused and adjust the portfolio to maintain attractive valuation parameters relative to the benchmark and the broader market. 

Media Holdings – Finally Appreciated
Our investment philosophy often leads us to areas of the market that are undervalued, underappreciated, or simply misunderstood. During the just completed quarter, the undervalued became fairly valued. Media conglomerate Gannett announced a bid for television station operator Belo Corporation in June. Both stocks are holdings in the Fund, and both stocks jumped sharply on the news.

The market recognized the synergistic benefits of the acquisition. In a typical acquisition, the acquirer’s stock declines (investors become concerned about how cash flow, leverage, and integration will affect profitability and operational efficiency) while the acquired company’s stock rises to the level of the purchase price. With the acquisition of Belo, Gannett gains significant economies of scale and becomes the fourth largest broadcast group in the country trailing only CBS, Fox, and Sinclair. This move appears to be widely interpreted as a positive for Gannett by having a larger component of its business come from more-profitable broadcasting revenues. 

Perspective and Outlook
U.S. equities have performed well and continue to be supported by a stronger and relatively stable U.S. economy. The coming earnings season will be important. While earnings per share numbers have held up well during the early stages of the recovery—in part due to dividends and share buybacks—the next test will be whether or not companies can show evidence of revenue growth.

During the second quarter, the Fed signaled that it is considering scaling back and eventually ending its quantitative easing (QE) program. While this has caused some near-term selling in the U.S. stock market, it is a good news/bad news story since the Fed will scale back the program only when economic growth is sustainable and unemployment levels are lower.

Higher interest rates may have anticipated a sooner end to monetary easing than the economic numbers support, as Fed Chairman Ben Bernanke implied in his latest comments. The trend in rates is now generally upward, however, and this will have positive implications for companies with large pension obligations, such as Fund holdings Unisys and New York Times. As interest rates rise, pension liabilities tend to be discounted at higher rates and therefore decline. 

Fairpointe Capital

Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager

As of June 30, 2013, First Solar comprised 1.87% of the portfolio’s assets, Boston Scientific – 4.41%, Akamai Technologies – 2.85%, McDermott International – 2.34%, Nuance Communications – 2.66%, Itron – 2.77%, Juniper Networks – 3.01%, Gannett – 2.04%, Belo – 1.79%, Unisys – 2.12%, and New York Times – 3.20%.

Note: 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.


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