2nd Quarter 2013
Ongoing signs of a recovery in the housing sector, strong corporate earnings, and more stability in the employment data continued to set a favorable backdrop for U.S. equities during the second quarter. Building on the rally early in the year, stocks were generally edging higher through late May when concerns that the Federal Reserve would taper its bond buying program triggered fears of rising interest rates and increased equity volatility through the final weeks of the quarter.
Core equity indices were generally up between 2% and 3% during the period, with small-caps at the higher end of that range. Performance differences varied greatly by style, however, with growth stocks measurably outperforming their value counterparts in the mid- and small-cap segments, while value stocks were well ahead of growth among large-caps. In contrast to the first quarter, there was wide variation in performance across sectors, with strong performance within the Consumer and Technology sectors and notable weakness in Energy stocks, commodity-related securities, and more interest-rate sensitive areas.
The Fund performed strongly in outpacing its Russell 2000 Growth Index benchmark by a sizeable margin during the quarter. Stock selection was positive in most sectors, especially from positioning in the Healthcare and Technology sectors. Select names within Industrials and Financials also added meaningfully to relative performance.
The primary drivers of outperformance within Healthcare were Vanguard Health Systems and Health Management Associates (HMA). A wave of health care reform-fueled consolidation has followed the hospital companies recently, driving both HMA as a potential target and Vanguard Health as an actual buyout up sharply. Vanguard Health was acquired by Tenet Healthcare in a deal announced in late June, boosting the stock nearly 40% for the quarter. Merge Healthcare was another winner, up 24%, as it continued to attract new clients to its medical image sharing software.
Internet software firms Brightcove (cloud-based media publishing) and Millennial Media (mobile advertising) were among the top performers in Technology. Millennial rebounded after a difficult first quarter. Debt and account receivables management company Encore Capital, a top-10 holding, was also up solidly within Financials.
The Fund underperformed the index in the Materials and Consumer Discretionary sectors, with stocks in the latter group leveling off or retracing after notable strength earlier in the year. Lumber company Boise-Cascade was the primary culprit in the Materials sector, dropping 25% on similar weakness in commodity wood prices during the period. In the Consumer Discretionary sector, specialty retail was an area of weakness for the portfolio, with underperformance from HSN, Vitamin Shoppe, and OfficeMax. We had held on to OfficeMax through the announcement of the company’s deal with OfficeDepot earlier in the year (we previously owned both names), but the stock has been choppy since and traded lower toward the close of the second quarter.
Seeking Unrecognized Growth
Our strategy is to achieve competitive returns by identifying unrecognized growth potential wherever it exists across all industry sectors. We seek to identify firms with high quality business models, distinct competitive advantages, proven management teams, and significant growth potential. Revenue growth, margin expansion, and the ability to positively surprise and revise estimates are key characteristics in our holdings. We want these firms to have duration and sustainability of these characteristics based on their competitive positions in the industry. We think our success stems from the experience and focus of our investment team, which possesses extensive knowledge of small-cap companies and their key industry drivers.
Lee Munder Capital Group, LLC
As of June 30, 2013, Vanguard Health Systems comprised 3.96% of the portfolio's assets, Health Management Associates – 1.10%, Merge Healthcare – 2.34%, Brightcove – 0.99%, Millennial Media – 1.14%, Encore Capital – 3.64%, Boise-Cascade – 1.99%, HSN – 1.11%, Vitamin Shoppe – 2.30%, and OfficeMax – 2.07%.
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.