2nd Quarter 2012
Global equities turned volatile and negative during the second quarter, erasing nearly half of the double-digit gains earned through the first three months of the year. The European debt crisis and its impact on elections in vulnerable countries have dominated the headlines, but a sharp slowdown in China and a reversal in some key economic signals in the U.S. also drove markets lower. Risk aversion returned as evident by yield on the 10-year Treasury dropping sharply to 1.58% at the end of June—barely off its all-time record low. The CBOE Volatility Index (VIX), a measure of equity volatility, reached a high for the year as the market traded off sharply in late May.
The poor U.S. economic signals during the period included disappointing employment and capital spending reports, a pullback in retail sales, and four consecutive months of declines in consumer confidence. Performance across industry sectors ranged from muted gains to severe declines, with leadership coming from anything that produced a yield or perceived areas of safety—such as Utilities, Healthcare, and Consumer Staples. In contrast, we saw sharply negative returns recorded in the Technology, Energy, and Materials sectors. The S&P 500 Index fell nearly 3% during the quarter, and small- and mid-cap stocks (as represented by the Russell indices) were down even more.
Strong Industrials, Weak Tech
Against this challenging backdrop, the Fund declined 3% during the second quarter, outpacing its Russell 2000 Growth Index benchmark. Stock selection in the Industrials and Telecommunications sectors drove most of the favorable relative performance. Within Industrials, a meaningful position in prison operator Geo Group boosted returns as the stock gained on a strong earnings release and the extension of a key contract in California. Accounts receivables management companies Encore Capital Group and Portfolio Recovery Associates were both up sharply, as was RailAmerica. The regional rail freight operator reported strong results, and buyout speculation further boosted the stock. The portfolio’s exposure to Telecom was limited, but both AboveNet and tw telecom outperformed during the period, with the acquisition of AboveNet by a privately held firm completed at the beginning of July.
It was a difficult quarter for commodity-related equities as holdings in the Energy sector served as a drag on performance despite the Fund’s underweight position. The portfolio also trailed the benchmark in Technology, one of the worst performing sectors during the quarter. Magnum Hunter Resources and Clayton Williams Energy underperformed in Energy as oil prices moved sharply lower, and the market did not respond well to Magnum Hunter’s recent secondary offering. Technology stocks, which had been a key source of strength for the Fund early in the year, lagged on poor results from VeriFone Systems and Polycom. Electronic payment system designer VeriFone fell sharply in late May after its earnings release given concerns about the company’s exposure to the eurozone. The company also had a patent infringement ruling go against it in June. Shares of Polycom declined as the company guided revenue and earnings estimates lower.
Our strategy seeks to achieve competitive returns by identifying unrecognized growth potential across all industry sectors. We seek to identify firms with high quality business models, distinct competitive advantages, proven management teams, and significant growth potential. Revenue growth, margin expansion, and the ability to positively surprise and revise estimates are key characteristics in the holdings in the portfolio. We want these firms to have duration and sustainability of these characteristics based on their competitive positions in the industry. We think that the experience and focus of our investment team, which possesses extensive knowledge of small-cap companies and their key industry drivers, allows it to identify the growth that we believe leads to positive long-term returns.
Lee Munder Capital Group, LLC
As of June 30, 2012, Geo Group comprised 4.86% of the portfolio's assets, Encore Capital Group – 2.13%, Portfolio Recovery Associates – 2.46%, RailAmerica – 0.00%, AboveNet – 0.00%, tw telecom – 3.39%, Magnum Hunter Resources – 1.14%, Clayton Williams Energy – 0.89%, VeriFone Systems – 3.02%, and Polycom – 0.00%.
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.