2nd Quarter 2011 Commentary - ASTON/Montag & Caldwell Mid Cap Growth Fund
The second quarter was another volatile one for equity markets. After reaching new highs in April propelled by generally positive first quarter earnings reports, the market embarked on a steady descent from early May to the middle of June as renewed concerns about the economy, the end of the Fed’s second round of quantitative easing, and a possible Greek default emerged. The market then rallied late to bring the major indices back to around the break-even level for the quarter. Not surprisingly, given all of the macroeconomic issues, investors sought the perceived safety of higher-quality, more-defensive areas of the market. Factors such as larger market-cap size, higher return-on-equity (ROE), and lower beta (a measure of statistical volatility) generally outperformed. Defensive-oriented sectors such as Healthcare, Consumer Staples, Telecom, and Utilities delivered positive returns while cyclical sectors generally lost ground.
Mid- and large-cap stocks led the way during the quarter in delivering modest positive returns, while small-caps suffered a setback as represented by the 1.6% loss to the Russell 2000 Index. Growth outperformed value across the market-cap spectrum with the Fund's Russell Mid Cap Growth Index benchmark comfortably exceeding its Russell Mid Cap Value Index counterpart by more than two percentage points, adding to its advantage for the year-to-date through the end of June.
Winners and Losers
The Fund kept pace with the benchmark during the quarter, finishing in a virtual dead heat with the index. In general, stock selection within Technology, Materials, and to a lesser extent Energy aided relative performance. Communications equipment firm Polycom was the Fund’s best performer as it continues to execute well and gain market share in the video conferencing space. We trimmed the position since it was the portfolio’s largest holding at the time and the stock was trading in excess of our estimated present value. Within Materials, Ecolab enjoyed strong gains on solid first quarter earnings. There are signs of encouraging progress on European profit improvement following a restructuring, which gives management confidence that the company can deliver even better earnings growth in 2012 and 2013.
Other standout individual holdings of note included O’Reilly Automotive and Mead Johnson Nutrition, a leader in pediatric nutrition products. O’Reilly reported a solid quarter with modest top- and bottom-line beats relative to expectations, leading us to add to the position. The story slowly is morphing from improving productivity and growth from acquisitions to one of organic growth and cash flow.
Sector allocation and stock picks within Healthcare, Consumer Discretionary, and Consumer Staples weighed on performance. Weakness in St. Jude Medical followed its strong gains during the first quarter, thus its decline may have been due to some profit taking. Harman International, Panera, and Dick’s Sporting Goods all dropped during the period in contributing to the missed results within Consumer Discretionary. Baking soda manufacturer Church & Dwight and spice-maker McCormick lagged among Staples.
Elsewhere, NVIDIA and Oceaneering International were among the biggest individual detractors from performance. NVIDIA was one of the weakest performers during the quarter and we continued to add to the position, averaging down the portfolio’s cost basis, on weakness as we expect strong earnings in the second half of the year driven by share gains in supplying chips to the smartphone and tablet markets. We harvested some gains in Oceaneering early in the quarter ahead of the downdraft in Energy. We view the recent pullback in oil prices as healthy as it helps sustain the cycle.
Positioning and Outlook
Continuing on the Energy theme, we sold one position from the portfolio during the quarter, Southwestern Energy, based on our concerns about the company’s heavy dependence on natural gas. It was replaced by a new position in Newfield Exploration, which is quickly diversifying its asset mix to include more oil and less natural gas. Although Southwestern continues to perform well, growing its production profile faster than the rest of the industry, we have become more cautious on the near-to-intermediate term outlook for natural gas prices. Conversely, the prospects for oil appear to be on more solid ground, and Newfield is rapidly growing its production in the Uinta Basin of Utah and the Bakken formation in North Dakota. We also added a new position in Sapient, a leading independent digital marketing and IT services firm. We believe the firm is well-positioned to benefit from the ongoing secular shift of ad spending from traditional media to the Internet. Unlike its competition, Sapient is uniquely capable of delivering both the front-end creative campaign and the back-end technology implementation to clients.
Looking towards the second half of the year, we think the market can continue to march higher from current levels, driven by sustained economic growth in the U.S. and abroad. We expect volatility to continue in the near-term, however, due to the uncertainty associated with the end of quantitative easing as well as the highly contentious negotiations on raising the federal debt ceiling. We hold out hope that the politicians will eventually do the right thing and reach a favorable resolution that brings forth a credible plan to significantly reduce our federal deficits and debt over the intermediate-to-long term without significantly imperiling the current fragile recovery. We believe that without the benefits of additional fiscal or monetary stimulus, the economy may have a tough time sustaining growth much above 2.0% to 2.5% because of the ongoing effects of deleveraging. Furthermore, corporate profit growth will likely downshift as companies face tougher comparisons and as rising input and labor costs affect historically high profit margins. It is under this framework, though, that we believe the period ahead continues to favor the higher-quality growth stocks that comprise the portfolio.
M. Scott Thompson, CFA Andrew W. Jung, CFA
July 1, 2011
As of June 30, 2011, Polycom comprised 3.27% of the portfolio’s assets, Ecolab – 3.23%, O’Reilly Automotive – 2.27%, Mead Johnson Nutrition – 1.36%, St. Jude Medical – 2.12%, Harman International – 1.10%, Panera Bread – 1.01%, Dick’s Sporting Goods – 1.04%, Church & Dwight – 1.87%, McCormick Company – 1.90%, NVIDIA – 1.80%, Oceaneering International – 1.69%, Newfield Exploration – 1.44%, and Sapient – 0.75%.
Note: Small- and mid-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.