2nd Quarter 2013
Although we are bottom-up, U.S. small-cap investors, the portfolio is not immune from the news events and gyrations of the global economy. Equity investors worried about slowing global growth during the second quarter due to news of a weakening Chinese economy and calls for capital by Chinese regional banks. In the U.S., Federal Reserve Bank Chairman Bernanke’s statement that the central bank might “take a step down in our pace of purchases,” dubbed “tapering” by market commentators, sent the yield on 10-year US Treasury bonds to a peak of almost 2.7% from a recent low of about 1.6%.
We suspect the equity market’s severe pull-back in the middle of the quarter may have been due to excessive worrying about the Fed’s gradual reduction in bond purchases. The initial reaction seemed as if the market was pricing in an assumption of near-term interest-rate hikes as well. The management teams of companies held in the portfolio tell us that liquidity and credit remain abundant in the U.S. Assuming that the Fed reduces the current monthly $85 billion pace of purchases by a reported $20 billion, bond buying of $65 billon per month is still a lot of liquidity being injected into the system, by our reckoning.
While equity markets did bounce back towards the end of the quarter, the above events did add uncertainty to the investing climate. We remain optimistic, however, despite our style tilt towards higher quality companies that appeared to face a modest headwind during the quarter. Lower-quality companies, with smaller market capitalizations, low or no earnings, lower returns on equity (ROE), and little or no dividends tended to outperform.
The Fund lagged its Russell 2000 Value Index benchmark during the period. Sector allocation was neutral to slightly negative relative to the benchmark overall, with only an overweight position in Materials and underweight to Consumer Discretionary detracting from performance. An overweight to Consumer Staples and underweight to Financials, notably a significant underweight to sharply hit real estate investment trusts (REITs) aided relative returns.
Stock selection was negative in the Technology and Consumer Discretionary sectors. Newer holding M/A Com Technology posted what we thought were solid results, but the stock disappointed. Within Consumer Discretionary, another new holding in online marketing firm ReachLocal also performed relatively poorly in response to reduced guidance from the weak U.S. small and medium business markets. Given that our thesis primarily revolves around continued penetration of non-US markets, and an anticipated boost to company margins, we continued to hold the position in the portfolio.
We added value with stock selection in Financials paced by regional bank and insurer FirstMerit, insurance holding company Horace Mann, and the aforementioned lower exposure to REITs. While the overweight position in Materials hurt relative performance, stock selection within the sector provided a boost. As metals and housing related stocks were weak, the Fund was paced by a huge gain in specialty paper company Glatfelter, the single best performer for the quarter, which rallied on news of a potentially significant accretive acquisition.
Buys and Sells
We eliminated holdings in Swift Energy, Tennant, and Innophos Holdings from the portfolio during the quarter. Although Swift appeared significantly undervalued on an asset basis, operating trends have been disappointing and we had concerns about cash flow versus production metrics and its impact on the balance sheet. The other two sells were relatively small positions that appeared fairly valued.
New positions of note in addition to ReachLocal included United Stationers, Stifel Financial, and Pebblebrook Hotel Trust. United Stationers is a leading national wholesaler of business products, specializing in office supplies, janitorial and break room supplies, and industrial maintenance supplies. It has been a solid cash generator, leveraging relatively modest top-line growth into high single to low double-digit earnings growth through aggressive share repurchases. We find the shares of this well-managed company attractive on a number of operational and valuation characteristics.
Stifel Financial is a mid-market broker/dealer providing private client, investment advisory, and other banking and financial services. It has a solid record of growing revenues the past 17 years by being an active acquirer. In a reasonable capital markets environment, we think revenue growth and expense savings can lead to low double-digit earnings growth the next few years. Pebblebrook (PEB) is a REIT specializing in upper scale hotel properties in major U.S. markets such as New York City, San Francisco, Los Angeles, and Washington, DC. We think the company is well managed and offers potential for fairly rapid growth in an improving economy.
We believe the U.S. economy is slowly but steadily improving. We are not overly concerned with the potential and pace of Fed “tapering”, as we expect gradually improving economic conditions to lead to a more self-supporting environment. Despite strong appreciation the past year, we think the portfolio remains attractively valued, and can build on gains realized thus far in 2013. We remain hopeful that improving merger and acquisition activity can have a positive impact on results, as we believe we own a target-rich portfolio of companies that could potentially be attractive to others.
Silvercrest Asset Management Group
New York, NY
As of June 30, 2013, M/A-COM Technology Solutions comprised 1.30% of the portfolio's assets, ReachLocal – 1.03%, FirstMerit – 2.24%, Horace Mann Educators – 2.66%, Glatfelter – 2.95%, United Stationers – 1.49%, Stifel Financial – 1.51%, and Pebblebrook Hotel Trust – 1.55%.
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.