1st Quarter 2014 Commentary - ASTON/TAMRO Diversified Equity Fund
1st Quarter 2014
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
Despite the volatility, both the Fund and its Russell 1000 Index benchmark ended the period in positive territory, with the portfolio trailing the index marginally. The overall stock selection effect was slightly negative, with strength in the Industrials, Technology, Healthcare, and Energy sectors offset by weakness in Consumer Discretionary and Financials. Sector allocation was also slightly negative due to a lack of Utilities, the best performing sector in the Russell 1000. The interaction effect was positive owing to an overweight in Industrials, the portfolio’s best-performing sector on a relative basis.
American Airlines Group in the Industrials sector and Skyworks Solutions and Facebook within Technology were among the portfolio’s biggest contributors during the quarter. American, now the largest airline in the U.S. following the merger of US Airways and the old American Airlines, was the Fund’s top holding and top contributor. The firm emerged from bankruptcy and completed the merger in December 2013. Although complete integration will likely involve some bumps in the road, we are confident in management’s vision and ability to execute, which should generate levels of profitability not seen before from a major U.S. airline. The company beat consensus earnings estimates during the period, while also reporting better-than-expected capacity utilization progress on merger integration.
Continued growth in mobile adoption as well as an attractive return on investment for advertisers continued to drive Facebook’s results higher. The company has developed a unique culture based on innovation that we believe has competitive advantage in scale, data to help advertisers, and a strong senior management team. Skyworks reported solid quarterly results and raised its dividend, boosting its shares.
Consumer names Best Buy and Amazon.com, along with financial servicing firm Ocwen Financial, were the biggest detractors from relative performance. Best Buy suffered a significant comparable sales shortfall and year-over-year gross margin compression from lower prices due to heightened competition during the holiday season. Quarterly sales performance was below expectations at Amazon. We still believe the company’s ongoing investments in technology, digital content, and fulfillment centers to support the future growth will present near-term challenges to profitability but pay off in the long run. We view the firm as a best-in-class, disruptive innovator led by visionary management team that will continue to take share from brick and mortar retailers. Finally, Ocwen was negatively affected by New York regulators’ decision to halt onboarding of mortgage servicing rights from Wells Fargo.
The Fund’s sector allocations result from opportunities we identify at the company level through our bottom-up fundamental analysis and valuation work. Notable adjustments from year-end 2013 were an increase in Healthcare and Consumer Staples due to purchases and a decrease in Consumer Discretionary sector due to sales. Industrials, Healthcare, and Financials were the three largest sectors in the portfolio, with Healthcare entering the top three at the expense of Consumer Discretionary.
Three new opportunities were identified in the Healthcare sector—DexCom, Gilead Sciences, and Auxilium Pharmaceuticals. DexCom develops and markets continuous glucose monitoring devices that allow diabetics the ability to more effectively manage their disease. It is the only pure-play manufacturer of these devices and presently has the most durable and accurate technology on the market. Gilead is a global biotech company that discovers, develops, and commercializes innovative therapeutics for patients suffering from life-threatening diseases. The company is the market leader in HIV therapies and is well positioned to become the market leader in Hepatitis C treatment following its 2011 acquisition of Pharmasset. We believe the differentiated offerings of both DexCom and Gilead should resonate with investors, and that they are game changers in terms of novel treatments in their respective markets.
Auxilium has been a laggard in recent years. It is a specialty biopharmaceutical company that markets and develops products for urology, orthopedics, and sexual health. In our view, there is significant upside potential for the shares given a proven CEO, product breadth, and sales capabilities gained through the recent Actient acquisition, and a potentially transformative pipeline. We view its risk-to-reward profile favorably, given an attractive valuation combined with low Wall Street expectations relative to the potential opportunity.
Elsewhere, Consumer Staples firm Keurig Green Mountain reached full position size within the portfolio. The company’s unique coffee brewer and K-cups have struck a chord with consumers and enticed Coca-Cola to make a 10% investment in the company. This should lead to new product offerings and expansion globally.
The decrease in the Consumer Discretionary sector came from the sale of three retailers. We took profits in GNC Holdings, while selling Coach and Bed Bath and Beyond due to prolonged periods of poor execution, with Coach specifically suffering from a loss of market share. We also sold Catamaran, a pharmacy benefit manager, in order to fund the purchase of what we viewed as better opportunities within Healthcare.
TAMRO Capital Partners
As of March 31, 2014, American Airlines Group comprised 3.04% of the portfolio's assets, Skyworks Solutions – 2.15%, Facebook – 2.70%, Best Buy – 1.73%, Amazon.com – 2.72%, Ocwen Financial – 1.55%, DexCom – 1.65%, Gilead Sciences – 1.90%, Auxilium Pharmaceuticals – 1.59%, and Keurig Green Mountain – 1.29%.
Note: Small- and mid-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.