3rd Quarter 2010 Commentary
It was a strong quarter for equities, as most major indices delivered double-digit gains for the quarter. We are of the mind that the market is continuing to grapple with the disconnect between tepid economic growth and more robust results coming from corporations, particularly those with a global business platform. As investors continue to be surprised by better performance from companies, pessimism is giving way to optimism in spite of the barrage of negative economic reports as well as less than optimistic general economic commentary. We find the commentary interesting but we find our companies results compelling and much more relevant.
The Fund outperformed its Russell 1000 Value Index benchmark during the third quarter. Stock selection and sector allocation were both positive with stock selection contributing 93% of the outperformance and sector allocation 7%. The five top positive individual stock contributors were Endo Pharmaceuticals, CF Industries, Copa Holdings, Patterson UTI Energy, and Altria Group. All of these stocks remain holdings in the portfolio as we continue to view them as value creating opportunities.
The sectors with the highest contribution for the quarter were Financials, Materials, Consumer Staples, Health Care, and Utilities. Financials has been a significant relative contributor since the launch of the Fund as we have continued to remain underweight the sector. Portfolio holdings in the area have predominantly centered on asset managers and specialty insurers, while staying away from regional and commercial banking stocks that dominate the benchmark holdings and weighting. We have yet to find a compelling combination of fundamentals and valuation to allow us to have greater exposure in Financials. Although not biased against the sector, we will not jump simply because it has been underperforming.
The portfolio is currently overweight Energy, Consumer Staples, Materials and Technology. With the exception of Consumer Staples, which is traditionally considered more defensive, all of the sectors have a tilt towards more cyclical growth. We are not making a stand on the macroeconomic outlook but we do believe that the collective companies in these sectors represent a higher percentage of value creating opportunities than our overall universe, the Russell 1000 Index.
Turnover within the portfolio was greater than average due to adjustments made for the reconstitution of the Russell indices at the end of June. Stocks sold on this basis were Diamond Offshore, Tidewater, Chesapeake Energy, and Freeport McMoran. The first three sales were to reduce the portfolio's Energy exposure to get back within guidelines. The last was a sale to realign the Fund's holdings within Materials. New additions to the portfolio purchased for the reconstitution were Colgate-Palmolive, Energizer, Dean Foods, and Avon Products. All were initiated as value creating opportunities to give the Fund needed exposure in Consumer Staples.
Other new positions initiated during the period were Waddell & Reed, Eli Lilly, and Corning. Each stock was purchased after first being identified as a value creating opportunity followed up with fundamental analysis to vet out the potential as a portfolio holding.
The result of this and related activity during the quarter was that we increased the Fund's exposure to Healthcare, Financials, Consumer Staples, and Technology. We decreased exposure to Energy, Materials, and Telecom.
It appears that the pendulum of market sentiment is gradually starting to swing in a more optimistic direction. We are not sure if it is because economic news is getting less worse or possibly actually getting better. The uncertainty is still weighing heavily in the minds of investors who view safety through the lenses of clarity. It finds many clamoring for assets that a casual observer would view as higher risk in terms of protection against inflation such as bonds and cash—which have miniscule yields. In contrast, equities appear to be quite attractive on the basis of earnings, cash flow, and dividend yields for investors willing to recognize the benefit of owning reasonably-priced long-duration assets.
Trade issues on a global basis are starting to truly usher in a new era where the irrelevant or less thought of have become the relevant. The BRIC (Brazil, Russia, India, and China) nations are exerting their economic growth muscles while developed markets appear to be in the penalty box for a well-deserved time-out after the transgressions undertaken amid a period of reckless spending. The key question is whether this new-found love for all that is not domestic is a lasting relationship or the passing fancy investment du jour.
As we look at companies in the portfolio, we think we may have found the answer. At least 60% of the Fund's holdings have more than 50% of their revenues coming from outside of North America generally, and the United States specifically. While we have never attempted to be a global or international manager with this strategy, many of the successful portfolio holdings have done it for us.
As a result, the Fund has a portfolio of companies that collectively are globally represented and relevant within their respective industries. We believe that as investors come to understand that having a diversified large-capitalization portfolio means that you really are a global investor, sentiment might change regarding domestic stocks as well as the direction of fund flows into non-equity assets. International investing is viewed as a more exotic and alternative way of getting alpha. Companies that we hold in the portfolio believe it is just good business sense to go where the demand happens to be on a global basis. Without worrying about currency moves impacting the overall portfolio, investors in the Fund have the opportunity to participate. Instead of seeking out the new frontier with a more narrowly defined approach, we are doing it in what we think is a more prudent and measured fashion.
This mindset is not priced into stocks in our opinion, and the realization will hopefully cause a divergence in the thinking about what simply happens in the United States economy and what happens to companies that just so happen to be based in the United States. By virtue of where many of the Fund's leading companies do business, the domestic economy is a factor but not necessarily the deciding one, and it is becoming less predictive of company fortunes.
We continue to be optimistic and pleased to be aligned with companies that seem to share our perspective of seeking opportunities where the fundamentals and the value proposition happens to be the most compelling. As we move through the quarter and the year, we will continue this process as we seek out value creating opportunities for investors in the Fund.
Randell A. Cain, CFA
October 7, 2010
As of September 30, 2010, Endo Pharmaceuticals comprised 2.81% of the portfolio's assets, CF Industries – 2.17%, Copa Holdings – 3.30%, Patterson UTI Energy – 1.88%, Altria Group – 2.56%, Colgate-Palmolive – 1.81%, Energizer Holdings – 1.24%, Dean Foods – 0.88%, Avon Products – 2.20%,Waddell & Reed – 2.97%, Eli Lilly – 1.97%,and Corning – 0.97%.
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.