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Oct 17 2011

3rd Quarter 2011 Commentary - ASTON/Herndon Large Cap Value

3rd Quarter Commentary


For many people, this phrase means Thank God It’s Friday. For this quarter, it means Thank God It’s Finished. The third quarter of 2011 was quite challenging, with the Fund's Russell 1000 Value Index benchmark posting its fourth worst quarter since Herndon Capital Management began running its large-cap strategy in July 2002. We have persevered since that time by being steadfast in our approach, though it was, as previously stated, quite challenging.

Performance for the benchmark was fairly broad with five sectors—Utilities, Consumer Staples, Telecom, Health Care, and Technology—outperforming the overall index. The defensive posturing of the market continued, as cyclical, more-economically sensitive parts of the market lagged the benchmark from almost three percentage points (Consumer Discretionary) to nearly nine percentage points (Materials). Concern over worldwide growth has become eerily similar to the mindset the market adopted in the 2008 to early 2009 time frame. We do not think the situation is the same but recent results in terms of stock market performance are quite similar.

The Fund bested the index by nearly a percentage point during the quarter, with holdings in eight out of 10 sectors outperforming their respective sector and/or the overall benchmark. The two sectors that lagged were Materials and Energy. Stock selection contributed 100% of the outperformance as sector allocation was slightly negative.

Solid Consumer Picks

The three sectors with the highest contribution during the quarter were Consumer Discretionary, Financials, and Consumer Staples. All of the portfolio’s holdings in the Consumer Discretionary sector outperformed the benchmark sector average. An underweight position in Financials along with stock selection that benefitted from less emphasis on market and credit-sensitive companies aided returns. Consumer Staples added value primarily as an overweight position in the sector with the second highest contribution to the benchmark’s performance.

Top individual contributors were Kinetic Concepts, TJX Companies, and Apple. Medical device and equipment maker Kinetic Concepts received a buyout offer that boosted the stock significantly, leading us to sell the position from the portfolio on the basis of it being an all-cash offer with limited upside. TJX benefited from being a discount branded retailer offering shopping solutions for cost-conscious consumers in a tough economy. New addition Apple’s value rose as the market shook off concerns about Steve Jobs stepping down as CEO, as the company appears capable of continuing to generate popular products. We continue to view both TJX and Apple as value creating opportunities, and each remains a holding in the portfolio.

The sectors with the lowest contribution to returns overall were Utilities, Materials, and Healthcare. Utilities was the best performing area of the benchmark during the quarter and the Fund lacked exposure as we have not identified any value creating opportunities in the sector. An overweight position and lackluster stock selection in Materials, the worst performing sector, also detracted from returns. Holdings in more cyclical areas were dependent on continued positive global Gross Domestic Product (GDP) growth. The lack of near-term confidence in this growth resulted in the underperformance of some of these holdings. Although the portfolio’s picks in Healthcare sector outperformed the broader benchmark, they underperformed the sector itself. An emphasis on predominantly specialty pharmaceutical companies faltered as the market sought refuge in larger-cap pharmaceuticals during a difficult quarter.

Stocks that were the greatest negative contributors to performance were Lazard, Cliffs Natural Resources, and Endo Pharmaceuticals. Finanical firm Lazard was penalized for exposure to Europe that encompasses about a third of its business mix, as well as overall exposure to market-related areas. Iron ore producer Cliffs Natural Resources suffered as concerns about global growth have lowered investors’ expectations of a continuation of the company’s growth prospects. Finally, Endo Pharmaceuticals continues to have to defend itself from concerns regarding the efficacy of its product pipeline. All three stocks remain portfolio holdings as we perceive the issues facing these companies as being temporary in nature.

Portfolio Positioning

Eleven stocks were eliminated during the quarter due to sector adjustments and/or valuation or fundamental issues, including American Express, Coca-Cola Enterprises, and Forest Laboratories. These changes were primarily driven by the dynamic interrelationships of the sectors as we seek to position the portfolio to exploit value creating opportunities. As we have noted before in regards to our investment philosophy, “We have a core process but no core holdings.” As a result, if stocks no longer appear to be value creating opportunities, we sell.

With the higher level of positions eliminated, we initiated a number of new purchases to the portfolio to compensate, notably Accenture, Abbott Laboratories, and Marathon Oil. Each stock was purchased after first being identified as a value creating opportunity followed up by fundamental analysis to vet out its potential as a portfolio holding.

The result of this and related activity during the quarter was that exposure to Energy, Technology, and Industrials increased, while stakes in Consumer Staples, Consumer Discretionary, and Materials decreased. As of the end of the third quarter, the portfolio was overweight Consumer Staples, Technology, Energy, Materials, and Consumer Discretionary, while significantly underweight Utilities, Financials, Telecom, and Healthcare.


“He was extremely tempted. Tempted to do what, he didn’t know. But he did know that, somewhere inside him, the familiar itch of anxiousness was beginning to fester. ‘What to do, what to do,’ he murmured…”

- Mad Hatter from Alice in Wonderland by Lewis Carroll (1865)

Like the Mad Hatter, we all have a temptation to look at current macroeconomic events and try to change our perception of reality, one that is heavily influenced by our emotions. We too feel the twinges of anxiousness when the market rises or falls by 3%, 4%, or 5% in a given market session. To not feel the real anxiety of the moment would make us less than human. But, how we react as investment professionals is the key. You, as investors, do not pay us for our fear. You pay us to overcome that fear and make sound, rational, and pragmatic investment decisions.

In our attempt to fulfill our responsibility, we look to our process. Our process has recently caused us to start selling down some of the areas that have been performing best in this challenging market and to begin embracing those areas that have been leading the way down. Market pundits abound to show the obvious error of our ways. But, to beat the market, by definition, you have to do something different than the market.

In making investments, we do not invest on Monday and expect to realize all of the opportunities on Tuesday, in terms of a literal tomorrow. Tomorrow for us has a long time frame associated with it. Within that time frame, we are much like farmers. We see the seasons of stocks played out in the holdings of the portfolio. There is a planting season, a weeding season, and a harvesting season.

During planting season we seek out value creating opportunities to populate the portfolio at the individual and sector level. During weeding season, we adjust sectors and holdings by underweighting or removing some to make room for those that might be more appropriate and timely. Next, during harvesting season, the stocks and/or sectors that realize the vision we determined during the planting season are reaped. Finally, we begin the process anew with the next planting season.

In reality and application, the dynamic process of portfolio management reveals a congruent and parallel expression of these seasons rather than following in a linear progression. Depending on the stock and the sector, it is always planting, weeding, and harvesting season. Coupled with this vision, we recognize that we are in a tumultuous period in the market. We know that we have no control over the absolute direction of the market. Thus, our objective is to continue to position the portfolio to best realize value regardless of the environment.

To answer the question posed by the Mad Hatter, “What to do, What to do …?”  Right now, we are seeing opportunities in areas that the market is ignoring or abhorring and we are lowering exposure to areas the market is embracing or finding safety and security. Why? Because we are constantly looking for the value creating opportunities that are present today. 

Randell A. Cain, CFA
Principal and Portfolio Manager
Herndon Capital Management
October 1, 2011

As of September 30, 2011, Kinetic Concepts comprised 0.00% of the portfolio's assets, TJX Companies – 3.99%, Apple – 2.67%, Lazard – 1.52%, Cliff Natural Resources – 1.15%, Endo Pharmaceuticals – 2.17%, Accenture – 2.04%, Abbott Laboratories – 1.18%, and Marathon Oil – 1.89%.

Note: Value investing involves buying the stocks of companies that are out of favor or are undervalued. This may adversely affect the Fund's value and return.

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.


Aston History (212 KB, PDF)
Capabilities Brochure (2 MB, PDF)
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Aston Subadvisers (490 KB, PDF)

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