2nd Quarter 2013 Commentary - ASTON/Herndon Large Cap Value
2nd Quarter 2013
To everything there is a season and a time to every purpose under the heaven.”
– Ecclesiastes 3:1
“There are three things that we cannot control—timing, duration, and magnitude.”
“We have been in the right place but at the wrong time.”
We have frequently used the above phrases, and reinforced these words, as a means of expressing our performance during good times and bad. When everything works, then you are in the right place at the right time. Rarely does everything work at the same time.
Stock picking is what we have historically done well. History is simply the retelling of someone else's story. Mystory (used intentionally as I take creative liberty with the lexicon) is me telling my own story so that what mystifies is no longer a mystery.
James Franco gave us an insightful portrayal of the Wizard of Oz in the movie, "Oz the Great and Powerful". This movie adaptation revealed Oz as a cheap charlatan fooling common people with tricks devoid of any real magic but full of suggestion that filled the voids of imagination and desire. It took him to the top. To remain there, those closest to him had to keep his secret. His secret was that he was a fraud.
I have often been asked the secret to my success as if I too have wielded some magic. Fortunately, I do not like to keep secrets and have generously shared my method as well as process with all who would care to listen. My method is quite simple—buy solid companies at prices that significantly discount their fundamentals and patiently wait for the market to correct the discrepancy that I see. From all I have read, learned, and observed, this approach is the essence of investing, especially value investing.
I read about great investors or investing methods in books such as The Intelligent Investor by Benjamin Graham, The Money Masters by John Train, and Common Stocks, Uncommon Profits by Phillip Fisher. Through these books and others, I learned about value investors such as Warren Buffett, George Soros, John Neff, Ralph Wanger, and Anthony Bolton, to name a few. All had or have a keen sense of value which can at times put them at odds with the market. But, capitulating at times of inconsistency or incongruence with market performance has not been the hallmark of any of these investors. Standing firm in times of adversity has instead made them legends. It has made them relevant and worthy to be read, studied, and observed. Hence, each has a prominent space on my bookshelf for me to find wisdom that defies convention.
The solace I have found with the investment sages throughout my nearly two decade investment career encourages me through this most recent stretch of the Fund’s performance. Each suffered some period or periods where the efficacy of their approach was questioned. Thus, the current anomalous period for me is not unique. When I consult with my highly regarded investment counselors of old, each offers the same advice that is given to anyone who dares to diligently and passionately embark on a lifelong career in investing … stay the course. You must do what you believe will work and ignore the temptation to do anything else.
Energy and Financial Laggards
In staying the course, the Fund underperformed during the second quarter in a fashion similar to the first quarter of 2013, with a few securities bearing the brunt of responsibility. Let me explain.
For the second consecutive quarter, six out of 10 sectors underperformed their respective benchmark sector and/or the benchmark overall. The result was underperformance for the quarter. Stock selection and sector allocation were both negative.
Performance for the Russell 1000 Value was narrow with only Technology, Consumer Discretionary, Financials, and Healthcare outperforming. The portfolio was overweight two of these sectors—Technology and Consumer Discretionary—though stock selection yielded less than desirable results. In addition, portfolio overweight stakes in Industrials, Consumer Staples, Energy, and Materials all were negative contributors to relative performance.
The sectors with the lowest contribution to returns were Energy, Financials, and Materials. Six of 11 stocks within Energy outperformed, but the laggards underperformed such that they overwhelmed the portfolio. Solid performers from the first quarter, refiners HollyFrontier and Marathon Petroleum, came under pressure during the second quarter as the spread between West Texas Intermediate and Brent crude narrowed. Underperformers within Financials came primarily from equity-oriented asset management companies such as Eaton Vance and Waddell & Reed, as well as real estate investment trusts (REITs) like Apartment Investment Management and American Capital Agency. American Capital especially struggled due to concerns regarding the direction of mortgage rates. Holdings in metals and fertilizers, such as Cliffs Natural Resources, Southern Copper, and CF Industries struggled within Materials.
The three sectors with the highest contribution for the quarter were Utilities, Telecom, and Consumer Discretionary. The portfolio benefited from having no exposure to underperforming Utilities and Telecom, while four of five stocks in Consumer Discretionary outperformed the sector led by luxury retailer Coach.
The top three individual stock contributors were CBOE Holdings, Western Digital, and Microsoft. Options exchange CBOE performed better given the higher volumes associated with greater recent market volatility. Hard disk drive maker Western Digital continued to report solid fundamentals in the face of expectations for a downturn, while Microsoft steadily chugged along on no specific news.
We emphasized in our first quarter commentary that we take great pride in our stock picking, and we reiterate that again by noting that 29 out of 55 stocks (53%) owned in the portfolio outperformed their respective sector and/or the overall benchmark. The magnitude of the negative performance of some of the laggards kept the portfolio from showing as well as we believe it is capable.
Stocks eliminated due to sector adjustments and/or valuation/fundamental issues were Harris Corporation, Cliffs Natural Resources, Gilead Sciences, Health Management Associates, ConocoPhillips, and Superior Energy. These changes were primarily driven by the dynamic interrelationships of the sectors as we position the portfolio to exploit value creating opportunities. Of particular note is that the Fund continued to hold many of the period’s laggards at quarter end knowing that we have little control over the timing of performance, and in recognition of the need to stay the course in confirmation of our process.
Five positions were initiated in Healthcare, including St. Jude Medical and United Therapeutics, plus Federated Investors and SLM Corporation within Financials. Each stock was purchased after first being identified as a value creating opportunity followed by fundamental analysis to vet out its potential as a portfolio holding.
The result of this and related activity during the quarter was increased exposure to Healthcare, Consumer Staples, Consumer Discretionary, and Financials. Exposure to Technology and Energy declined, while all other sectors remained essentially the same outside of market appreciation or depreciation.
When asked why he robbed banks, illustrious bank robber Willie Sutton is noted for saying, “That’s where the money is.” In fact, Sutton denied ever having actually made that statement. But, it does make sense. In addressing the question, Sutton said, “Why did I rob banks? Because I enjoyed it. I loved it. I was more alive when I was inside a bank, robbing it, than at any other time in my life…”
We have continued to maintain a posture towards pro-cyclical growth-oriented sectors such as Energy, Materials, Technology, and Consumer Discretionary coupled with primarily multi-national Consumer Staples. Why? Put quite simply, because in our opinion that is where the value is. It does not bring me great joy to underperform or not meet shareholder expectations. But, I believe I know where the value is and how to seek the opportunities to realize it.
The value is currently in sectors where the market has shown low confidence and conviction in spite of what we believe are solid fundamentals. The way that we get it is by vetting attractively priced securities that we believe give us a better than average chance of outperforming. The vetting process leads to purchase. The purchase leads to the key … patience.
We believe we will be vindicated in following our investment process as the market makes a more rational assessment of the holdings in the Fund. As previously stated, the majority of the portfolio’s securities outperformed, kept at bay by the magnitude of underperformance among a few laggards.
As we look to the third quarter, we see great value in the identified areas. Unless purchasing securities at a significant discount to what the fundamentals merits has gone permanently out of fashion, we are confident that the portfolio will eventually turn for the better. If our assessment of the values of portfolio’s holdings is correct, the turn has the potential to be significantly better.
Randell A. Cain, CFA
Principal and Portfolio Manager
Herndon Capital Management
July 1, 2013
As of June 30, 2013, HollyFrontier comprised 2.03% of the portfolio's assets, Marathon Petroleum – 2.48%, Eaton Vance – 1.98%, Waddell & Reed – 1.99%, Apartment Investment Management – 2.19%, American Capital Agency – 1.42%, Cliffs Natural Resources – 0.00%, Southern Copper – 1.32%, CF Industries – 1.47%, Coach – 1.97%, CBOE Holdings – 2.71%, Western Digital – 2.83%, Microsoft – 2.21%, St. Jude Medical – 0.94%, United Therapeutics – 0.95%, Federated Investors – 1.08%, and SLM – 1.00%.
Note: Value investing involves buying the stocks of companies that are currently out of favor and may decline further.
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.