2nd Quarter 2011 Commentary - ASTON/Crosswind Small Cap Growth Fund
The Fund outperformed its Russell 2000 Growth Index benchmark by more than three percentage points during the second quarter as the index posted a slight loss. Small-growth stocks continued their advance from the first quarter into April, but quickly cooled down in May and June as economic news soured. The Fund gained most of its ground over the index in April, and then was able to maintain its outperformance , even adding to it slightly, during the subsequent pullback.
Several times during the quarter significant pull backs in many strong growth companies that have been high flyers and large weights in the benchmark came through our screens. Many of these companies passed our fundamental due diligence, but did not pass the valuation step of our investment process. When this happens, we typically move them to a watch list and set a price alert to see if a stock reaches a price that makes sense to us. We eventually took advantage of the volatility and declines in some of these names and established positions in those that we believe have solid fundamental growth stories.
One of the ways in which we identify these potential growth stories is by focusing on growth that is seemingly unrecognized by the market. Fiber optic network operator Global Crossing caught our eye by increasing revenues in the high single-digits and expanding margins at a rate in the mid-teens. Although those figures don't appeal to most small-growth investors who typically seek revenue growth north of 15% to 20%, especially in the Telecom sector which only comprises less than 2% of the benchmark, we viewed the firm as a stable business with a track record of generating significant free cash flow. This April, it was announced that Level 3 Communications planned to acquire Global Crossing at a 60% premium, driven by the desire for Global’s proprietary network in Latin America, Europe and Asia.
Another way in which we root out growth opportunities is to focus on key drivers. Software company Blackboard provides learning management solutions to K-12 schools and universities. After a strong early growth run after its initial public offering, it seemed that many investors saw the finite number of schools as potential customers as a limiting factor to the firm’s long-term growth rate. We think that this view underestimated Blackboard’s ability to grow through selling additional software applications to its existing customer base and overestimated the potential for customers to go elsewhere to open source software, which is seldom as “free” as it seems once the necessary consulting and support costs are considered. Disregarding this market “noise”, we made the stock a top position in the Fund on weakness during the first quarter of 2011. The stock subsequently shot up during the second quarter as a number of universities announced that they would renew their contracts with Blackboard, validating our thesis, and as the company announced that it had hired Barclays to advise them on several unsolicited takeover offers. We then trimmed the position significantly in line with our price target discipline given the uncertainty as to the identity of the potential buyer.
To be most effective, we think this discipline should be followed at both ends of the spectrum. Tenet Healthcare drew attention from the public towards the end of 2010 (as discussed in our fourth quarter commentary) when another hospital system, Community Health, offered to acquire them. There has been much public discussion regarding the takeover and the tactics used on both sides, and the topic has stayed in the news on into 2011. We viewed all the hype as noise. We felt strongly about the fundamental growth story behind the company, and believed that if there were to be a potential buyer it would not be Community Health. As it became clear during the second quarter that the takeover was not likely, the stock dropped. We continue to evaluate Tenet based on its fundamentals and believe there is significant potential upside in the stock given its growth profile. Thus, we added to the portfolio’s position during the period on the dip, and it remains a top position in the Fund.
The Fund had a strong quarter that has put it ahead of its benchmark for the year-to-date through June 30. We continue to stay focused on our investment process that seeks unrecognized growth by rooting out the key drivers of each stock and maintaining discipline with price targets. We believe that these three aspects enable the team to take advantage of inefficiencies in the small-cap growth market. We remain optimistic the current environment will continue to provide quality ideas for the portfolio.
Crosswind Investments, LLC
As of June 30, 2011, Global Crossing comprised 0.00% of the portfolio's assets, Blackboard – 2.38%, and Tenet Healthcare – 4.75%.
Note: Small-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
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.