3rd Quarter 2012
The Fund trailed the broad equity market (as represented by the S&P 500 Index) by several percentage points during the third quarter as stocks rebounded from a lackluster second quarter. Returns failed to keep pace due to our strategy of using options to manage the volatility of the portfolio in an attempt to deliver smoother long-term returns. The use of Put options to hedge the portfolio against downward swings suffered as the market mostly climbed higher during the period. The selling of Call options on certain underlying holdings also detracted from returns, as those stocks subsequently exceeded the strike prices on our Calls.
The option strategy was the primary detractor from performance as the portfolio’s underlying holdings performed in line with the broader market overall. Positive individual stock selection was offset by weak sector allocation relative to the S&P 500. The two areas that contributed the most to relative returns were the Consumer Staples and Industrials sectors, while underperformance came from Technology and Utilities.
Given what we consider the defensive nature of the portfolio—with its emphasis on divided-paying large-cap stocks with low price/cash flow ratios—we would argue that on a risk-adjusted basis the underlying equity positions did quite well relative to the S&P 500. We continue to concentrate the portfolio in traditionally defensive sectors of the market, notably Utilities.
Although we do not manage the portfolio by holding large cash positions, we do hedge against market risk by owning Put options. As long as the cost of the Put options remain low relative to historical norms, we will maintain that hedge against potential market corrections. In our opinion, the economic and political risks are too great to ignore. We are disinclined to be tactical in our hedging approach by making short-term directional moves.
Senior Portfolio Manager
Note: By selling covered call options, the Fund limits its opportunity to profit from an increase in the price of the underlying stock above the exercise price, but continues to bear the risk of a decline in the stock. A liquid market may not exist for options held by the Fund. If the Fund is not able to close out an options transaction, it will not be able to sell the underlying security until the option expires or is exercised. While the Fund receives premiums for writing the call options, the price it realizes from the exercise of an option could be substantially below a stock’s current market price. Premiums from the Fund’s sale of call options typically will result in short-term capital gain taxes, making it ill suited for investors seeking a tax efficient investment. The use of derivatives by the Fund to hedge risk may reduce the opportunity for gain by offsetting the positive effect of favorable price movements. There is no guarantee that derivatives, to the extent employed, will have the intended effect, and their use could cause lower returns or even losses to the Fund.
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.