3rd Quarter 2010 Commentary
Pick Up in M&A Activity Boosts Sentiment
Market volatility increased during the quarter as the glacially slow expansion of the global economy and lack of an obvious trend created an environment where sentiment changes had an exaggerated effect on stock prices. While certainly not a smooth ride, sentiment towards equity markets improved considerably in September, helping to drive a significant move higher in stock prices.
Acceleration in merger and acquisition activity (M&A) dominated headlines during the period. The consolidation news was not limited to any one industry and was a global phenomenon, noted by large premiums offered at above market prices and bidding wars from leading companies for must-own services. A pick-up in M&A activity is significant because savvy corporate bidders tend to identify real value in their industries before investors in general. With mid-term elections only a month away, investors could very well be looking forward to clarity on the future outlook on taxes and regulations. This reduction in uncertainty may create a tailwind from fiscal policy that could join forces with the existing tailwind of monetary policy. We remain optimistic with regard to the economy and the stock market. Business and consumer sentiment has been soft for quite a while and we could be seeing the spark that puts a smile on people's faces. Stocks may be signaling such an event.
3Par and F5
The Fund significantly outperformed its Russell 1000 Index benchmark during the quarter. Portfolio results were dominated by stock selection within Technology, highlighted by a take-out offer made on 3PAR and a strong second quarter earnings report and increased guidance from F5 Networks. 3PAR received an offer from Dell of $18 per share which was quickly countered by a higher offer from Hewlett Packard. Hewlett Packard ultimately won out with its $33 per share all-cash offer. The Fund took profits in 3PAR as the bidding war heated up, fully exiting the position by the end of the quarter.
In addition, stock selection within Consumer Staples and Consumer Discretionary further aided returns. CarMax and BorgWarner both delivered strong results, and benefited from improving conditions in the new and used auto markets. Stock selection in the Energy and Financials sectors were the main detractors from relative performance. Regional bank BB&T Corporation missed earnings expectations and the firm continues to be plagued by concerns regarding its loan portfolio. Bank of America also lagged, mainly on worries of the impact of new financial regulations. We sold the latter position from the portfolio in favor of other holdings such as Metropolitan Life, a financially strong insurance industry leader in which we have greater confidence.
Importantly, the trend in increased capital investment in the corporate enterprise segment, where cloud computing is capturing much of corporate spending, figured prominently in the two strongest stocks in the portfolio (3PAR and F5 Networks) during the quarter. Cloud computing allows companies to utilize the Internet as the medium to access information that historically had been stored in a company's data center. Given the increased complexity of information flow and storage, cloud computing technology saves money and provides more efficiency. We believe we have identified the leading innovators in this area. We also believe cloud computing is at a nascent stage and is one of the most revolutionary changes in corporate IT in 30 years.
The Fund continued to maintain a broadly diversified portfolio with a similar profile to that at the end of the prior quarter. Companies we categorize as Leaders and Innovators comprised 91% of assets in the portfolio while Laggards, or companies undergoing restructuring, made up 9%. Consumer Discretionary, Technology, and Industrials were the largest sectors in the portfolio, whereas Telecommunications (no holdings), Utilities, and Materials had the smallest weights. After substantial portfolio adjustments last quarter, changes during the third quarter were characterized more by what we refer to as nipping and tucking—where we seek to take advantage of valuation disparities. We will often trim a position where the valuation has become a bit stretched and redeploy the proceeds by adding to positions that we believe are more attractively valued.
The one stock in which the Fund initiated a new position was Research In Motion (RIMM). Although Apple and Google have made inroads into the consumer smart phone market, RIMM still maintains a lead in the global corporate market and has had budding success in the consumer market. Valuation is at historic lows across all metrics, although revenue and earnings continue to grow in excess of 20%. We believe the lack of optimism for RIMM underestimates the difficulty in penetrating the corporate environment, where RIMM has earned its share by focusing on security—a critical component to success in business environments. The catalyst for a potential acceleration of revenues is the launch early next year of its tablet device, named the Playbook.
In addition to 3PAR and Bank of America, the Fund exited its position in Yahoo! Yahoo! was sold due to potentially better opportunities among other equally cheap stocks.
TAMRO Capital Partners
As of September 30, 2010, 3PAR comprised 0.00% of the portfolio's assets, F5 Networks – 2.64%, Dell – 2.50%, Hewlett-Packard – 0.00%, CarMax – 3.13%, BorgWarner – 2.66%, BB&T Corporation – 2.23%,Metropolitan Life – 2.05%, Research In Motion – 1.30%, Apple – 0.00%, and Google – 2.37%.
Note: Small- and mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
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.