3rd Quarter 2011
The third quarter was marked with uncertainty from all angles of the macroeconomic landscape. The US debt ceiling, the US credit downgrade, uncertainty regarding Europe and its financial institutions, and sovereign risk in general all came together during the period to foster an environment of extreme risk aversion. The Fund’s Russell 2000 Growth Index benchmark dropped more than 22%, as the downward pressure on stocks during August and September erased positive gains from earlier in the year. The Fund itself lagged the benchmark by a sizeable margin.
Although painful, we believe such periods of volatility often create greater inefficiency in the small-cap growth market that can lead to medium and long-term opportunities. Many of the holdings in the portfolio reported solid results during the quarter and maintained financial guidance for the year. Our investment team continues to stick to its discipline of identifying companies with strong underlying fundamentals and revenue growth, margin expansion, and surprise potential. Strong balance sheets are especially important during these times. One can never be certain how long these periods of fundamental and market volatility can last, but we remain confident that solid fundamentals will prevail over the medium- and longer-term.
Two notable individual detractors from performance during the quarter were Healthsouth and Monster Worldwide. Healthsouth is a leading inpatient- rehab hospital system that was sold from the portfolio during the first quarter of 2011, when it hit our price target. We do continue to monitor stocks even after they are sold and will revisit them if stock price dips back down and the fundamentals remain intact. In early August, many healthcare services stocks, including Healthsouth, sold off sharply in response to headlines regarding budget reform for Medicare and Medicaid. We think the company is in an extremely robust fundamental position, with a dominant market share in its industry and a strong balance sheet, which had improved since it was sold from the portfolio. After conducting several checks with regulatory bodies/company management, we concluded that the sell off was overdone and added the stock back to the portfolio.
Online job site and top-10 holding Monster Worldwide suffered from the steady outpouring of lackluster employment reports and job growth. Despite the dim macroeconomic news, though, Monster continues to report solid revenue and cash-flow growth. We think media hype about social networking sites like Linkedin hampering the online job market is overblown, as the overlap concerns only a portion of its business. The firm is also generating significant growth internationally, which formerly was a detractor to its business, and we believe international business will continue to drive future growth. In another sign of confidence in the fundamentals, there was insider buying from Monster management during the quarter.
Individual contributors that stood out on the positive side relative to the benchmark were Radiant Systems and Jarden. Radiant is a leading provider of software systems and terminals to restaurants. The firm had been growing revenue in the mid-to-high teens and had a cash rich balance sheet from its burgeoning Software as a Services (SAAS) business that helps restaurants better control inventory and link information from several restaurant sites. In early July, the company’s growth potential was realized when NCR, a leader in point-of-service terminals and self-service kiosks, announced they were acquiring Radiant to expand their offerings in the hospitality industry.
Consumer products conglomerate Jarden continued to deliver solid revenue and cash-flow growth. The firm has demonstrated its ability to hold up well in a recessionary environment with sales relatively flat during the worst periods of 2008. In fact, Jarden acts more like a Consumer Staples than a Consumer Discretionary stock. During the quarter, the company announced a significant share repurchase as its stock continued to trade at a discount to peers. In addition, it was recently highlighted in a Barron’s article, suggesting others may finally be starting to recognize the fundamental strengths of the firm.
In summary, we remain committed to our discipline of identifying good companies that are growing revenues, expanding margins, and have strong balance sheets in order to weather this storm. The Fund has seen some short periods of relative underperformance amid a volatile market environment as holdings in the portfolio are noticeably different from that of the benchmark. Yet, we think these volatile periods have seeded the portfolio with opportunities as the small-growth market becomes more inefficient, creating a larger pool of companies with the unrecognized growth characteristics we seek trading at what we consider attractive prices. We certainly cannot advise as to how long this period of volatility will last, but we feel confident in the prospects of the portfolio in the medium- and longer-term.
Crosswind Investments, LLC
As of September 30, 2011, Healthsouth comprised 4.57% of the portfolio's assets, Monster Worldwide – 2.75%, Radiant Systems – 0.00%, NCR – 0.00%, and Jarden – 6.53%.
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.