4th Quarter 2013
It was another strong period for small-cap stocks as the Fund’s Russell 2000 Value Index benchmark gained 9% during the fourth quarter. All sectors within the index appreciated at least 5%, with Materials, Healthcare, and Industrials leading the way and Utilities, Energy, and Consumer Staples among the weaker sectors. Although trends were somewhat mixed during the quarter, we agree with BofA Merrill Lynch analysts that lower-quality stocks prevailed for the year as smaller, non-earning, higher debt, lower S&P-rated, lower return-on-equity (ROE), higher beta (volatility), low-priced, and non-yielding issues stood out on the upside. With that backdrop, we are particularly proud of the Fund’s relative performance, as the portfolio tends to have less representation in these lower-quality baskets. The Fund slightly underperformed its benchmark during the quarter, but outperformed for the full year.
As is typical for our strategy, we added to relative returns during both the quarter and the year through stock selection, with the vast majority of that coming from Financials. BancorpSouth far outpaced its sector and the overall index during the quarter. It also was a standout performer for the whole year as well, along with Horace Mann Educators, PacWest Bancorp, and FirstMerit. After years of headwinds, an underweight stake in real estate investment trusts (REITs) aided returns for both the quarter and year as a rising interest rate environment took its toll on the capital-dependent holding companies.
Other sources of relative outperformance during the quarter came from the Industrials and Consumer Staples sector. Industrial transmission and motion control (brakes and clutches) manufacturer Altra Industrial Motion led the way in the former, while specialty food firm Lancaster Colony paced the portfolio in the relatively small Staples arena.
The Fund’s worst sectors for relative performance during the quarter were Energy and Materials. Independent oil and gas firm Rosetta Resources posted negative returns that weighed on the portfolio’s Energy holdings, while Sensient Technologies was the laggard in Materals. The weakest areas of performance for the year were Technology (hurt by a decline in Vishay Intertechnology), Healthcare (a sharp decline in Invacare), and Energy (by Swift Energy).
Buys and Sells
During an active quarter, we initiated six new positions in a diverse group of industries, including, CBIZ, CVB Financial, Stepan, and Knoll. CVB Financial is a high-quality California based bank earning an above average return-on-equity (ROE), with solid capital and a healthy dividend yield. The company has many attributes we seek in a bank—a history of profitability, a heritage of sound credit underwriting, disciplined expense management, and a simple business model.
Stepan is a chemical company that primarily manufactures surfactant chemicals, which are chiefly used in consumer and industrial cleaning products such as detergents for clothes and dishes, shampoos, body washes, toothpastes, and fabric softeners. The company also produces polyols used in the manufacture of thermal insulation products in commercial construction, autos, boating and other consumer products. We view Stepan as an attractive investment due its core surfactant business, which has anchored relatively stable revenue and earnings growth. The company also stands to benefit from exposure to a potential recovery in nonresidential construction in the U.S., continued growth of personal care products in Brazil, as well as growth from European commercial insulation. Stepan was reasonably valued at the time of acquisition and has a strong dividend growth record (46 years of consecutive dividend increases).
CBIZ is an old name for us that we have owned before. Although earnings per share have been stagnant the past five or six years, we think the recent sale of the company’s more volatile Medical Management Professionals business and the adoption of the Affordable Care Act may be the catalysts to enable this services provider to small- and medium-sized businesses to grow earnings. We found the shares attractive, selling at a discount to its peers, with a reasonable balance sheet and free cash flow. Knoll is the smallest of the four publicly-traded North American office furniture manufacturers. Although recent results have been under pressure due in part to its exposure to government sales, we think the firm’s sales and margin goals are attainable in an improving economy. The recent opening of its flagship retail store and showroom (our neighbor downstairs) has raised expense levels, but is expected to raise awareness.
Five positions were eliminated during the quarter—AFC Enterprises, Protective Life, Prosperity Bancshares, Chemtura, and Teledyne Technologies. Each of these companies appeared to be at or near our estimates of fair value when sold and/or had above average market capitalizations.
Looking to 2014, we think the broad U.S. economic picture remains constructive. Our colleague Stan Nabi notes that the U.S. economy is creating jobs at a two million per year pace with wage gains exceeding inflation. Consumption demand seems strong, evidenced by solid increases in retail and auto sales. Even the housing sector, temporarily stalled due to mortgage-rate increases, seems poised to resume its rebound due to pent-up demand. Corporate America continues to deliver record earnings and cash flows that far exceed capital spending needs. We think surplus cash can be productively put to work in shareholder friendly ways such as acquisitions, share repurchases, and higher dividends.
Putting aside the optimism of our macroeconomic outlook and whether our conservative style is in vogue or not, we remind investors that we carefully select individual company investments. We seek companies that can outperform in any environment. We do that by adhering to an investment philosophy and process that seeks attractively priced companies earning high or improving returns on capital and deploy those proceeds in productive and shareholder friendly ways. We think the portfolio is currently reasonably valued.
Lastly, and officially in “broken record” status after many quarters of opining, we continue to believe there is significant potential within small-caps in general, and the portfolio in particular, for increased merger and acquisition activity. We remain hopeful that activity will perk up and the Fund will catch its share.
Silvercrest Asset Management Group
New York, NY
As of December 31, 2013, BancorpSouth Educators comprised 2.28% of the portfolio's assets, Horace Mann Educators – 2.53%, PacWest Bancorp – 2.11%, FirstMerit – 0.64%, Altra Industrial Motion – 2.19%, Lancaster Colony – 1.85%, Rosetta Resources – 1.70%, Sensient Technologies – 1.11%, Vishnay Intertechnology – 1.42%, Invacare – 0.00%, Swift Energy – 0.00%, CBIZ – 1.39%, CVB Financial – 1.46%, Stepan – 1.38%, and Knoll – 1.26%.
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