2nd Quarter 2012
Following a strong first quarter, equity markets again fell back on concerns about the financial stability of the euro zone and slower economic growth. Apprehension about the policies of a new government in Greece dominated the news from Europe, while growth in China slowed significantly and the U.S. economy grew at a lackluster rate. This uncertainty continues to give companies pause in making investments in facilities or people, and it has created volatility in financial markets worldwide as investors react to the headlines.
This market volatility was certainly evident in the month-to-month performance of the Fund during the second quarter. Both the portfolio and the its S&P MidCap 400 Index benchmark were down in April and May, but recovered during the last two weeks of June to end the period on a strong, positive note. What is important to realize is that our long-term focus and discipline aided us in not overreacting to the short-term volatility early in the quarter in keeping the Fund positioned to benefit from the June surge. We remain focused on investments in companies with positive long-term outlooks and attractive valuations. Over time, we think our process has worked, as evidenced by the Fund’s multi-year track record.
Long-term Holdings Contribute
Several long-time holdings in the portfolio benefited from our patience, boosting returns in June and minimizing the Fund’s earlier underperformance during the quarter. Home healthcare services provider Lincare Holdings rose substantially, driven by takeover speculation that ultimately proved correct. (On July 2, 2012, Linde AG, a German gases and engineering company, announced that it had signed a definitive agreement to acquire Lincare.) The merger allows Linde to expand its market base considerably in the United States. We are encouraged by this announcement and believe that other recently announced acquisitions could be the beginning of a renewed trend as larger multinational companies look to the U.S. for “growth by acquisition”.
The New York Times Company was the second best performer during the quarter as the company announced first quarter results that were better than consensus estimates. Circulation revenues increased 10%. The launch of digital products and new platforms has been very successful, with the company reporting more than 470,000 paid digital subscriptions (up 16% since the fourth quarter). Southwest Airlines benefitted from moderating fuel prices and a recent analyst recommendation as the third best contributor to performance.
The worst performing stocks during the second quarter were FMC Technologies, Lexmark International, BorgWarner, Manpower Group, and Akamai Technologies. With the exception of Akamai, all suffered owing to concerns about worldwide economic growth, with international revenues accounting for more than 50% of proceeds for each of those companies. Akamai, with 28% of revenues from non-U.S. markets, was affected more by concerns regarding the firm’s gross margins, which we think are overblown. We are encouraged by the recent, significant purchases of additional company shares by a founder of Akamai.
Buys and Sells
We added two new stocks to the portfolio during the second quarter—NVIDIA and Cree. NVIDIA is a leading supplier of graphics processors used in electronic devices from smart phones and tablets to supercomputers. We expect more use of graphics processors as demand for fast, high-quality graphics increases on all devices. The stock has been under pressure recently from supply constraints on a new generation of chips, but we anticipate supply and demand increasing during the coming year potentially resulting in improved earnings.
Cree uses proprietary technology to produce semiconductors and LED components, LED chips, and LED lighting products. We believe that the demand for LED lighting products will increase significantly over the next several years. LED lighting is considerably more energy efficient than incandescent lighting and lasts years longer than traditional bulbs, resulting in significantly lower operating costs. The company reorganized its sales and distribution earlier this year, which had a negative impact on revenues and earnings. We think the transition is mostly complete, and expect higher revenues and earnings in future quarters.
CA was the only holding sold during the period. The stock hit our price target much quicker than anticipated. As concerns about a declining backlog developed during the second quarter concerns, we decided that there was little upside left at its current valuation and exited the position with a healthy gain.
While economic growth worldwide remains uncertain, Europe appears to be making progress towards stabilizing its financial situation. In the U.S., we see signs of improved economic activity as June car sales jumped 22% and the housing market appeared to be strengthening. Lower gasoline prices should have a positive impact on consumer spending and confidence.
Although the second quarter underperformance was disappointing, we have experienced similar instances of short-term market volatility. We believe that the U.S. stock market has discounted many of the macroeconomic issues that are out there, and view the portfolio as attractively valued based on company fundamentals. During the 13 years we have managed the Fund, we have only seen the overall portfolio with a lower price/earnings-to-growth (PEG) ratio three times (October 2002, October 2008, and September 2011), giving us confidence in current valuations.
Rather than abandon a rational investment process during volatile periods, we remain focused and committed to the process that has served us well. We believe the portfolio is well positioned, and that our patience will be rewarded over time.
Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager
As of June 30, 2012, Lincare Holdings comprised 2.06% of the portfolio’s assets, The New York Times Company – 3.60%, Southwest Airlines – 3.15%, FMC Technologies – 2.32%, Lexmark International – 2.77%, BorgWarner – 1.75%, Manpower Group – 1.98%, Akamai Technologies – 3.33%, NVIDIA – 1.42%, and Cree – 1.87%.
Note: Mid-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.