1st Quarter 2012
The Fund substantially outperformed its Russell 1000 Value benchmark during a first quarter that saw most broad equity indices deliver double-digit returns. Portfolio holdings in eight out of 10 sectors outperformed their respective benchmark sector and/or the overall index. The only sector that underperformed was Telecommunications, where the Fund had no exposure. Overall, stock selection was positive and sector allocation was slightly negative.
Performance for the benchmark itself was fairly broad with five sectors—Financials, Consumer Discretionary, Technology, Materials, and Industrials—outperforming the overall index. All sectors had a positive return with the exception of last year’s leading sector, Utilities. Utilities declined 1.6% as it appeared that investors favored less defensive area of the market given greater confidence that the U.S. economy might be recovering.
Strong Tech Showing
The three portfolio sectors with the greatest contribution to returns during the quarter were Technology, Healthcare, and Industrials. Five out of six holdings in Technology outperformed, while Healthcare fared similarly well with four out of five stocks outperforming their sector peers. Industrials performed well with an eclectic mix of companies benefiting from a more favorable economic environment.
The three top individual contributors were Apple, Copa Holdings, and Federated Investors. Apple continues to surge on better than expected fundamentals coupled with the initiation of a share buyback program and the announcement of the firm’s first ever dividend, which broadened its appeal to a wider shareholder base. Copa Holdings, parent of Copa Airlines, continued to deliver solid results within Industrials despite concerns over fuel prices. The valuation of Federated Investors rebounded from what we considered a draconian discount at the end of last year based on an outcome regarding potential reserves for money market funds that ignored the diversified and profitable nature of the bulk of its businesses. Each of these stocks remains in the portfolio as we continue to view them as value creating opportunities.
The sectors with the weakest contribution to performance were Financials, Energy, and Telecom. Only Financials produced an overall negative contribution, as a significant underweight position in the sector relative to the benchmark overcame eight percentage points of excess return from stock selection. Positions in Energy and Telecom managed to slightly outperform the benchmark.
The biggest individual detractors from performance were RPC, Caterpillar, and Campbell Soup. Oil well service and equipment provider RPC suffered from concerns about the stability of oil prices. The drop in Caterpillar’s stock reflected investors’ concerns about global growth. The defensive characteristics of Campbell Soup became less prized amid a potentially more robust domestic economic situation. Of the three, only Campbell Soup was sold during the period.
Corning Out, CBOE In
In addition to Campbell Soup, notable sales from the portfolio during the quarter included Corning and Eli Lilly. The stocks eliminated were due to sector adjustments and/or valuation/fundamental issues. These changes were primarily driven by the dynamic interrelationships of the sectors as we position the portfolio to exploit value creating opportunities. As we share regarding our investment philosophy, “We have a core process but no core holdings.”
New positions were initiated in trading exchange CBOE Holdings, credit card issuer Discover Financial Services, and Caterpillar. Each stock was purchased after first being identified as a value creating opportunity followed up with fundamental analysis to vet out the potential as a portfolio holding.
On a sector level, the result of this and related activity during the quarter was an increase in the portfolio’s exposure to Financials, Energy, Consumer Staples, and Industrials and a decrease in Telecom, Technology, and Materials. The Fund’s biggest sector overweight position remains Energy, followed by Consumer Staples and Technology. The most significant underweight was Financials, though less so, and the portfolio had no exposure to Telecom or Utilities at the end of the period.
The first quarter began with quite a bit of fanfare. The economy appeared to be picking up, unemployment declined, and Greece did not fall off the face of the earth—staving off a technical default. The Republican nomination process seems to be cascading to an end. The rest of the world appears to be growing at a less aggressive pace. Questions are being answered in the market, which fills the information vacuum that the market abhors. Did things get dramatically better over night? No. But, as is said, it is always darkest before the dawn as if a new day is not ever going to emerge again.
We are pleased that many of the Fund’s holdings, such as Federated—which delivered less than satisfying returns during the fourth quarter—reversed the trend in a meaningful fashion. We dare not run a victory lap because we understand the fickle nature of the market. She loves me. She loves me not. In the first quarter, she loved me. The next quarter is a new day.
We are glad to see that the recovery, although still being somewhat dismissed by some, appears to be gaining solid traction. Corporations are still trading at attractive levels with cash hoards that should eventually find a way to generate additional shareholder value.
We believe the portfolio is positioned well on a fundamental and valuation basis to take advantage of the current environment. The stocks in the portfolio represent holdings in solid companies that we think still have a level of disbelief priced in that makes them opportune investments. Once the aura of attraction fades, we will take profits and redeploy into other, similar opportunities that have yet to catch the market’s fancy.
With such a strong gain to start the year, a pullback would make sense. But, we think that over the long-term an upward direction is more sensible. We are not market prognosticators but as allocators of investor capital, we do pay attention. And the alternatives to equities are not quite as attractive. Thus, perhaps 2012 will be a favorable year for equity holders.
Randell A. Cain, CFA
Principal and Portfolio Manager
Herndon Capital Management
April 9, 2012
As of March 31, 2012, Apple comprised 3.39% of the portfolio's assets, Copa Holdings – 3.60%, Federated Investors – 3.06%, RPC – 0.62%, Caterpillar – 0.93%, CBOE Holdings – 1.00%, and Discover Financial Services – 1.03%.
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, consider the Fund’s investment objectives, risks, charges, and expenses. Contact 800 992-8151 for a prospectus or summary prospectus containing this and other information. Please, read it carefully. Aston Funds are distributed by Foreside Funds Distributors LLC.