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Feb 9 2011

4th Quarter 2010 Commentary - ASTON Value Fund

4th Quarter 2010 Commentary

The year started off with a continuation of the trends we saw in 2009—lower-quality companies leading the charge as investors became increasingly optimistic with regards to the prospects for a global economic recovery. The European Sovereign Debt crisis during the spring called all of that into question and a significant pull back in global markets ensued. This along with questions about the pace of recovery drove market correlations to all-time highs, muting the benefit of stock selection for active managers such as ourselves. We were encouraged to see correlations decline during the fourth quarter, however, and are optimistic about the opportunities for active managers moving forward.

Although pleased that 2010 resulted in positive absolute returns for investors, we were disappointed not be able to add any relative value during the year. Taking a look back, it's important to note that substantially all of the Fund's underperformance occurred during the two periods (February to mid-April; December) when the "risk-on" trade was back in vogue and market interest in lower quality companies—which we don't own in the Fund—was quite high.

In addition, the dramatic outperformance of smaller-cap companies was another headwind during the year. Looking at the performance of the Fund's Russell 1000 Value Index benchmark by market-cap quintile, the smallest companies (bottom quintile), a significant underweight in the portfolio, outperformed the largest companies (top quintile) by a large margin. Great performance from a few of the smaller-sized names in the portfolio did help a bit, but the difficulty faced by maintaining a disciplined focus on owning large-cap companies was unmistakable—accounting for roughly half of the negative attribution in 2010.

Fourth Quarter Review

The Fund underperformed its benchmark during the fourth quarter of 2010. The main drivers of underperformance came from stock selection in Industrials, Consumer Staples, and Materials. Defense contractor Lockheed Martin continued to come under pressure as the company reduced its future guidance for 2011 due to larger than expected pension expenses and near-term issues with its all-important Joint Strike Fighter (JSF) platform. Higher-than-expected capital expenditure guidance and muted expectations going forward from 3M weighed on its shares during the period.

Within Consumer Staples, shares of Philip Morris International took a breather following a strong stock price performance during the third quarter on slightly weaker-than-expected cigarette volumes and pricing trends. A more competitive pricing environment in the cereal category caused General Mills to lower its guidance for the first half of 2011, resulting in negative reaction to the stock price.

An underweight position in Utilities aided relative performance during the quarter along with stock selection within the Financials sector. After underperforming the market during the third quarter after announcing an equity deal to finance its purchase of AIG's international insurance operations MetLife reported good quarterly results leading to a rebound during the fourth quarter. Investors in Custody bank and asset manager State Street looked favorably on the firm's announcement that it was eliminating 1,400 jobs globally in an attempt to leverage its scale and business process improvements.

Other notable performances came from Accenture, Oracle, and Energy firms National Oilwell Varco and Hess. Consulting firm Accenture posted solid quarterly earnings. The company also raised its revenue guidance for 2011 on the back of strong year-over-year consulting and outsourcing bookings. Oracle continued margin improvement on both its hardware and software segments from stronger maintenance contracts and continued cost rationalization. Strong oil prices sent the shares of National Oilwell Varco and Hess higher well in excess of the market during the quarter.

Positioning and Outlook

The biggest change in the portfolio during the quarter was a decrease in exposure to both the Utilities and Energy sectors and increased exposure to the leisure and Technology areas. We felt it made sense to pull back a little from Energy and Utilities after the recent positive performances in both areas. We decreased the Fund's weighting in a couple of electric power companies along with trimming back in Energy in the face of $90 per barrel oil prices.

Within leisure, we initiated a position in a fast-food restaurant based on its attractive valuation relative to what we feel is a very strong, well-managed franchise with strong prospects going forward. The increased exposure in Technology was due to increased allocations to a software and a computer systems company.

Looking ahead, we remain much more optimistic regarding the prospects for the companies owned within the portfolio than we do about a dramatic rebound in global economic activity. We are not making investments based on the direction and magnitude of the global economies moving forward, as much as we are on high-quality businesses with strong balance sheets and solid free cash flow generation that we think are intelligently allocating capital. When considering the risk/reward opportunities we see in the market we are compelled to continue upgrading the quality of the companies held in the portfolio given the opportunity to do so at increasingly attractive valuations. Regardless of what happens in 2011, we believe that the portfolio of companies is well-positioned to create relative and absolute value over the coming quarters and years ahead.

MFS Investment Management

As of December 31, 2010, Lockheed Martin comprised 3.09% of the portfolio's assets, 3M – 1.25%, Philip Morris International – 4.00%, General Mills – 1.75%, AIG – 0.00%, MetLife – 2.52%, State Street – 1.75%, Accenture  – 2.72%, Oracle – 2.68%, National Oilwell Varco – 0.00%, and Hess – 1.79%.

Note: Value investing often involves buying the stocks of companies that are currently out of favor that may decline further.

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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