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Jul 14 2010

2nd Quarter 2010 Commentary - ASTON/Fortis Real Estate

2nd Quarter 2010 Commentary

Economic Worries Come to the Fore
North American REIT returns suffered for the second month in a row in June, resulting in a drop in the Fund's MSCI US REIT Index benchmark of 4% during the quarter. Macroeconomic, fiscal and regulatory concerns all played huge negative roles during the quarter with worries about a double-dip recession emerging. The Fund outperformed the benchmark during the period, driven almost entirely by stock selection.

Stock picking was positive across most property sectors within the portfolio, with holdings within the Multi-family, Office, and Healthcare sectors being particularly strong. The biggest individual contributors included Multi-family names Essex Property Trust and Equity Residential.  Both are large overweight positions within the portfolio relative to the benchmark.  Another healthy overweight position, Nationwide Health Properties, was also a large positive contributor to the Fund's excess performance during the period. 

Portfolio Positioning
Currently, the Fund's largest sector overweight remains in the Malls area, driven largely by bottom-up factors as Simon Property and Taubman remain attractive from a valuation perspective.  During the period, the Fund sold Tanger, an owner of outlet centers across the US, based on a less healthy relative valuation. The second largest overweight sector is the previously mentioned Multi-family sector after adding significantly to the portfolio's position in Avalon Bay during the quarter. Fundamentals for the sector continued to improve faster than expected at this point in the economic cycle, especially in light of weaker than expected job growth. Looking ahead, a period of sustained job growth, even if somewhat muted, coupled with very limited levels of new supply over the next three years and still very low borrowing costs bodes well for this area.

Canada continues to be a source of relative strength in the current strained environment, and we increased the Fund's Canadian weighting during the period by adding to its stake in shopping center company Riocan, as well as adding Canadian Real Estate Investment Trust (CREIT) to the portfolio. Canadian valuations compare quite favorably with the U.S., and macroeconomic factors provide less downside risk to returns in Canada. The country' economy and fiscal situation is the envy of most of the G20 nations.  Although earnings growth rates in the US will likely exceed those in Canada by a meaningful measure as the recovery unfolds, current valuations in the U.S. appear to take that into consideration while Canadian REITs continue to look relatively attractive.

Other sectors of note were Lodging and Industrials. Surprisingly, Lodging was the top-performing sector in 2009 and remains near the top so far in 2010. Results have surpassed expectations as the recovery has unfolded, and new supply remains in-check. We increased the portfolio's weighting in the sector a bit during the period by increasing its stake in Host Hotels. Within Industrials, we sold AMB Properties from the portfolio and trimmed Pro Logis. Both of these companies possess global industrial portfolios, and while global trade has picked up, rental rate and net operating income gains are still a ways off for the sector. 

The negative returns witnessed over the past few months were by no means a total shock to us as we had expected a reprieve, or at best a "treading water", given the strong returns early in the year on the heels of healthy returns in 2009. While some events obviously caught us by surprise (i.e. Greek Debt crisis), slower economic growth than many had expected here in the U.S. did not. In last quarter's commentary, we noted our concern that the tepid recovery has largely been a function of government spending and that the largest element of GDP, consumer spending, had continued to lag due to continued high unemployment. The crisis of confidence currently affecting many in the US, as reflected in the markets, continues to concern us, especially in the near-term.

With much of the balance sheet repair behind them and the capital markets open to them, many REITs are well positioned at this point in the cycle, however. As organic growth begins to pick up in 2011 and beyond, external opportunities should present additional avenues of growth given that many possess cost-of-capital advantages as well as access to capital that should allow greater scale efficiencies versus private and smaller public players.

Given the recent selloff the, we feel incrementally more positive on the prospect for North American REIT returns going forward. Valuation levels appear more reasonable, especially considering that our fundamental operating outlook for REITs remains intact and positive. North America REITs now look appropriately, if not slightly under-valued. When coupled with a second quarter earnings season that is not expected to disappoint, our expectation is for a slightly positive return outlook in the near-term.

Fortis Investment Management

As of June 30, 2010, Essex Property Trust comprised 4.65% of the portfolio's assets, Equity Residential – 8.23%, Nationwide Health Properties – 4.46%, Simon Property Group – 12.9%, Taubman Centers – 4.26%, Avalon Bay Communities – 6.65%, Riocan – 1.17%, Canadian Real Estate Investment Trust  – 0.45%, Host Hotels – 4.67%, and Pro Logis – 0.92%.

Note: Real estate funds are non-diversified and may be more susceptible to risk than funds that invest more broadly. Risks include declines from deteriorating economic conditions, changes in the value of the underlying property, and defaults by borrowers. Investing in foreign markets also entails the risk of social and political instability, market illiquidity, and currency volatility.

Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.

Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.


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