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Apr 17 2014

1st Quarter 2014 Commentary - ASTON/TAMRO Small Cap Fund

1st Quarter 2014

Spring Forward?
After a meteoric rise in 2013, equity markets seemed to be running in place at the beginning of 2014, as most indices posted minor gains or losses during the first quarter. It was a bumpy ride marked by dramatic swings in share prices and investor sentiment. Growth in real Gross Domestic Product (GDP) was 2.6% during the fourth quarter despite tepid growth for the majority of 2013, raising hopes that the economy and stock market were poised to spring forward.

The Federal Reserve seems increasingly confident that the economy is on firmer footing, reiterating its decision to pare back its monthly bond-buying program. This suggested that not only could tapering be completed by year-end, but that interest rates could rise soon thereafter. Although such actions remain conditioned on improving economic fundamentals, the more confident tone from the Fed seemed to unnerve investors accustomed to highly supportive monetary policy.

We don’t believe in fighting the Fed. We also believe that the stock market offers investors a good opportunity. We expect the economy to continue its gradual recovery, with better positioned companies benefitting from the moderate economic growth and subdued levels of inflation. 

Winners and Losers
The Fund’s final returns for the quarter somewhat masked the intra-period volatility of the market. The portfolio posted a modest loss in trailing the 1.12% gain for its Russell 2000 Index benchmark. The underperformance relative to the benchmark was primarily due to stock selection, mainly in the Industrials, Technology and Consumer Discretionary sectors. Overweight stakes in Consumer Discretionary and Industrials also detracted from returns, while the lack of exposure to the Utilities sector, the best performing sector in the benchmark during the quarter, weighed on performance as well.

Among the largest individual detractors from performance were Polypore International, Westport Innovations, and Tyler Technologies. Filtration system manufacturer Polypore suffered from increased concerns about the impact of a patent infringement lawsuit with a key South Korean customer. Auto parts supplier Westport missed its quarterly estimates for sales and profitability, and provided limited guidance for its growth prospects. Concerns about the company’s ability to execute its strategy led us to sell the stock from the portfolio.

Lumpiness in Tyler Technologies’ bookings put pressure on its stock. Tyler has carved out a well-defined niche as a software developer and IT service provider with a focus on the public sector—more specifically, state and local governments, school districts and other local government entities. The company has a leading market share within this historically underserved client base, and a management team well experienced serving public sector clients that have been with the firm for roughly 15 years. We still see the shift towards modernizing these government entities as a big driver for Tyler’s business, despite the recent rough patch.

An overweight in Consumer Staples and underweight in Technology helped relative performance, along with strength in the holdings in Energy, Financials, and Healthcare. Carrizo Oil & Gas provided additional details on its oil-focused growth strategy for its Eagle Ford acreage, which was well received by the market. Healthcare stocks Auxilium Pharmaceuticals and DexCom were also standouts. Specialist biopharmaceutical firm Auxilium reported strong innitial uptake for two of its drugs, while DexCom reported stronger than expected sales growth as well as Food and Drug Administration (FDA) approval for its continuous glucose monitoring technology for pediatric Type 1 diabetes.  

Portfolio Positioning
There were only modest changes to the portfolio at the sector level during the quarter. Healthcare replaced Consumer Discretionary among the top-three largest sector stakes in the portfolio, joining Financials and Industrials, due more to market strength in the former and weakness in the latter than active shifts in holdings.

Changes at the stock level were driven by a focus on companies where we had a higher level of conviction, and away from more established operators with less growth potential. For example, among specialty retailers in Consumer Discretionary we filled out positions in retailers Five Below and Francesca’s Holdings where we believe longer-term growth potential superseded the outlook for Chico’s FAS and Zumiez (both sold from the portfolio). Five Below focuses on the youth market with items priced at $5 and below—hence the name.  Francesca’s targets the young professional female on a budget with a differentiated offering in apparel and accessories. This investment is a restructuring story with a new, but experienced management team that is positioning the company for its next stage of growth.

Hawaiian Holdings and Barnes Group became full positions within Industrials. Hawaiian is a regional airline that has spent the past several years building its fleet of planes to expand its routes both internationally and domestically. The company’s capital spending peaked in 2013 and should result in a corresponding improvement in revenues sparked by the servicing of new and optimized routes. We believe the recent focus on investment should increase its visibility and profitability.  Barnes is a diversified company with a focus on aerospace and industrial equipment and services.  The company has been a long-term leader in its industry, yet new management has found ways to improve operating margins with acquisitions in its industrial division. The aerospace segment stands to benefit from the upcycle in commercial aircraft production. These investments replace more established operators, notably Raven Industries, where long-term opportunities do not resonate as strongly in our view.

Lastly, in Technology, we introduced supply chain software provider Manhattan Associates, while Tyler Technologies, and VeriFone Systems reached full position status. All three companies possess a strong niche business with few competitors.

Eleven full positions were sold from the portfolio during the first quarter, some of which have been noted above. In addition, Harman International Industries and Athenahealth were sold as they surpassed our typical market-cap threshold of $5 billion. We sold Foster Wheeler given its recent plan to be acquired by a third party at a slight premium. 

TAMRO Capital Partners
Alexandria, Virginia

As of March 31, 2014, Polypore International comprised 0.24% of the portfolio's assets, Westport Innovations – 0.00%, Tyler Technologies – 1.66%, Carrizo Oil & Gas – 3.04%, Auxilium Pharmaceuticals – 2.33%, Dexcom – 3.30%, Five Below – 1.68%, Francesca’s Holdings – 1.61%, Hawaiian Holdings – 1.70%, Barnes Group – 1.53%, Manhattan Associates – 1.85%, and Verifone Systems – 1.75%.

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.


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