2nd Quarter 2012 Commentary - ASTON/Silvercrest Small Cap Fund
2nd Quarter 2012
Perceived good news emanating from the European Summit meetings ignited a powerful rally on the last day of the quarter, sending small-cap indices up close to 3% and illustrating the see-saw dynamics of the U.S. equity market both during the second quarter and for the year.
High-quality versus low-quality trends were mixed during the quarter, but investors showed a clear preference for U.S.-oriented companies given concerns about Europe and signs of a slowing Chinese economy. According to Credit Suisse, companies in the Russell 2000 Index with no international sales exposure lost a median of less than 1%, while those with high international exposure lost 9%. Bank of America/Merrill Lynch research found that the three sectors within the Russell 2000 that derive less than 10% of their sales outside of the U.S. (Utilities, Financials, and Healthcare) were the three best performers during the quarter, while the three sectors with the most international exposure (Technology, Materials, and Energy) were the worst performers.
Strong Consumer and Technology Picks
The Fund outperformed its Russell 2000 Value Index benchmark amid an ultimately declining market during the quarter despite the final day rally. It was a difficult environment for active managers, with investor sentiment gyrating wildly depending on the perception of news from Europe and China. Bank of America/Merrill Lynch research also determined that only 13% of value funds beat their benchmarks during the second quarter.
Stock selection was the basis for most of the value added by the portfolio versus the benchmark. Holdings in the Consumer Discretionary, Consumer Staples, and Technology sectors delivered the best returns during the period. Consumer Discretionary was led by AFC Enterprises, franchiser of the Popeye’s restaurant chain, which continued to post better-than-expected results under the leadership of relatively new CEO Cheryl Bachelder. An overweight to the outperforming Consumer Staples sector boosted returns on the back of Core-Mark Holding. We think Core-Mark is an underfollowed stock as a supplier to the convenience store industry, where it continues to deliver strong earnings as it ramps up its distribution services. Lastly, electronic payment software firm ACI Worldwide, a standout last quarter, continued to perform within Technology.
Asset allocation relative to the Russell 2000 Value was negative overall, with a substantial underweight to Financials detracting from performance during the quarter. Financials was the second-best performing sector in the index, fueled by a surge in REITs (Real Estate Investment Trusts) where the Fund was noticeably underweight as well. Stock selection within Financials only modestly underperformed, with Prosperity Bancshares being the worst performer.
Dismal stock selection in Energy also detracted from returns. The Fund’s two exploration and production holdings, Swift Energy and Rosetta Resources struggled in a poor commodity pricing environment for natural gas and natural gas liquids. We continue to see value in both names, however, and believe they will rebound with higher commodity prices.
We initiated only one new position in Bob Evans Farms during the quarter. We think the company’s earnings power will increase as its restaurant remodel program progresses, driving higher same store sales and margins. Several potential catalysts could lead to a higher stock price, including the sale of its struggling Mimi’s Café chain, a spin-off of the Food Products division, and/or a sale/leaseback of company owned real estate.
We eliminated positions in Plexus, Albany International, and A. Schulman. Although we think Plexus is a fine company, we thought the upside was limited as the company backed away from a longstanding target of 10% gross margins. We sold Albany following a poor quarterly earnings report that caused us to question our thesis that a steady cash flow stream from their paper machine clothing business would carry the company until more exciting opportunities in the aerospace industry developed later this decade. We ultimately decided we could wait for the opportunity in aerospace to move closer to fruition. Heavy European exposure seems like it will pressure the share price of Schulman over the next few quarters, leading us to part with that holding.
Despite all the investor angst over European sovereign debt issues, slower economic growth in China, sluggish economic trends in the US, and the looming “Fiscal Cliff,” the Fund has achieved strong returns for the first six months of 2012. On a company level, holdings in the portfolio remain attractively valued, balance sheets in general are in solid shape, and free cash flow generation remains strong. We continue to believe we are on the cusp of a more interesting environment for merger and acquisition activity, and are hopeful that any clarity on tax legislation following the November elections may prove to be a catalyst. Although the next couple of quarters could be choppy as we enter the campaign cycle in earnest and Europe continues to grapple with its problems, we think there is enough valuation support among small-caps to build on its year-to-date gains over the balance of the year.
Silvercrest Asset Management Group
New York, NY
As of June 30, 2012, AFC Enterprises comprised 2.65% of the portfolio's assets, Core-Mark Holding – 2.23%, ACI Worldwide – 2.14%, Prosperity Bancshares – 2.09%, Swift Energy – 1.63%, Rosetta Resources – 2.17%, and Bob Evans Farms – 1.43%.
Note: Small-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
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.