2nd Quarter 2013 Commentary - ASTON/Cornerstone Large Cap Value Fund
2nd Quarter 2013
The second quarter began with a continuation of the strong market returns witnessed throughout 2012 and the first quarter of 2013. The Fund’s Russell 1000 Value Index benchmark gained more than 6% during the first seven weeks of the quarter on the heels of a 12.3% return the previous quarter. Beginning in late May, however, investor appetite for risk began to evaporate around the globe amid renewed political instability, violent clashes in North Africa, and rising oil prices. In addition, the Federal Reserve began hinting that it may pull back on its unprecedented low-rate policies. As a result, markets experienced increased volatility and declines in many areas of the market traditionally viewed as safe havens—with municipal bonds and dividend-paying stocks experienced some of the largest declines.
Overall, the benchmark finished the quarter up 3.2%, as seven of 10 sectors within the index delivered positive results. Technology, Consumer Discretionary, and Financials were the three best performing sectors, while Materials, Utilities, and Energy were the worst as all three posted losses. The Fund slightly outperformed the benchmark for the period.
An underweight position in the Consumer Staples sector and stock selection within Financials helped drive the Fund’s outperformance. In addition, the absence of exposure to Utilities, Materials, and Telecommunications aided relative performance. Each of those sectors traded down as investors focused on the prospect of a tightening money supply from the Fed.
Three tech companies—Microsoft, Western Digital, and Google—were among the top individual contributors to performance during the quarter. Despite the weakness in the global PC demand, Microsoft’s non-PC business remained resilient. Its Server and Tools business continued to be a bright spot for the company. Western Digital continued its strong performance since 2011, delivering strong quarterly results with margins holding steady despite weakness in PC demand. Inventory levels declined during the quarter and the street viewed these results positively.
Google advanced materially following a positive first quarter earnings announcement in mid-April, as the company reported revenue up 31% year-over-year and earnings ahead of consensus expectations. The company also announced that its average advertisement price was declining at a slower rate relative to previous quarters, helping to drive profitability above expectations.
The three sectors that detracted most from performance were Consumer Discretionary, Healthcare and Technology. Stock selection within all three sectors was the primary detractor from our performance. The slew of individual tech winners noted above were unfortunately matched by an equal number of tech losers.
Apple, Qualcomm, and IBM all posted noteworthy losses for the period. Apple’s weak stock performance was driven primarily by the company’s legal battle with Samsung. The stock began to sell off in early June after the US International Trade Commission ruled that Apple had infringed on Samsung’s patents in wireless technology. The Commission subsequently issued a cease and desist order banning imports of some older Apple products. In late June, a Tokyo high court upheld a lower court’s ruling that Samsung did not infringe on Apple's patent for synchronizing music and data across devices, further weakening investor sentiment around the stock.
The market was disappointed in Qualcomm’s quarterly earnings as the company reported a decline in the average selling price of its smartphones and an expected overall slowing of global demand for smartphones post 2014. IBM reported its first earnings shortfall since the first quarter of 2005. The market was obviously disappointed with the results, and investors appear concerned with new CEO Ginny Rometty disappointing so early out of the gate. Longer term, the market seems focused on whether IBM’s goal of reaching $20/share in earnings by 2015 is achievable.
Finally, Oracle was an underperformer for the second quarter in a row. The company reported disappointing earnings and below-consensus guidance for the second half of the year. Weakness in the software sector was affected by macroeconomic uncertainty, especially in the Far East and Latin America. The market is concerned that the firm isn’t well positioned to manage the increasing transition to cloud based solutions. It did, however, announce that it is doubling its dividend and increasing its share repurchase authorization.
Despite the market’s strong performance during the first half of 2013, we think valuations remain compelling according to traditional measures and our proprietary valuation work. The Cornerstone Fair Value Model now indicates that 60% of the stocks in our 800 stock universe are undervalued relative to our assessment of their value. Using normalized earnings, we calculate the price of our universe at 76.8% of fair value.
We added two new names to the portfolio, Bed, Bath & Beyond and Norfolk Southern, during the quarter and exited two others. Household retailer Bed, Bath & Beyond has underperformed the broad market S&P 500 Index significantly the past year as investors focus on the online threat posed by Amazon. We believe these fears are overblown and that the fundamentals are strong across the company’s diverse retail base. In addition, the management team is considered to be amongst the best in the entire retail space, its balance sheet is exceptional and we find the valuation highly compelling.
Railroad operator Norfolk Southern not only engages in the rail transportation but transports overseas freight through various Atlantic and Gulf Coast ports and provides a range of logistics services. Although the stock has outperformed its peers and the market year-to-date, it has underperformed for the past one-, two-, and five-year periods. The market’s biggest concern is the amount of exposure it has to the coal market (currently 23%) and the impact that will have going forward. We find the stock attractively valued.
We sold online auction site eBay and premium industrial company Eaton from the Fund after each delivered strong performance since their purchase in 2012. eBay has performed well on positive trends in its Marketplace segment and long-term Payments. The stock had been one of the top contributors to performance during the past 15 months, and given that performance its valuation is now less compelling. Our investment thesis of strong fundamentals across various business lines, superior management, and a proven track record at Eaton has played out nicely the last 12 months and its current valuation no longer warrants maintaining a position within the portfolio.
We continue to find considerable value in the market. We are enthusiastic about the Fund’s positioning and our ability to improve the quality of the holdings within the portfolio while owning market leading, cash-flow rich, and attractively priced companies. We seek not to be swayed by the “noise” in the market, which appears to be changing quarter to quarter. While there may continue to be periods of strength and weakness, we endeavor to not stray from our process which we think is time tested, sensible, and proven over time.
Cornerstone Investment Partners
As of June 30, 2013, Microsoft comprised 4.31% of the portfolio’s assets, Western Digital – 3.97%, Google – 4.08%, Apple – 3.44%, Qualcomm –3.64%, IBM – 2.30%, Oracle – 4.06%, Bed Bath & Beyond – 2.41%, and Norfolk Southern – 1.93%.
Note: Value investing often involves buying the stocks of companies that are currently out of favor that 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.