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Oct 18 2012

3rd Quarter 2012 Commentary - ASTON/TAMRO Small Cap Fund

3rd Quarter 2012

The Consumer Is King

Investors caught the summer breeze during the third quarter and pushed U.S. equities to new highs for the year. Although the economy provided some forward momentum, it was the Federal Reserve’s September announcement of open-ended quantitative easing that ensured the period would end on a positive note. With Europe seemingly on the verge of a severe recession and Asian economies decelerating, the U.S. economy continues to find its footing. Why? In America, the consumer is king, and consumer sentiment is at a post-recovery high despite persistent above-average unemployment. That may seem like a conundrum, yet housing is central to the American economy and after falling for nearly six years since its peak in 2006, an upturn in home prices is fueling the positive trend in consumer sentiment.

Not only is the U.S. consumer king, but his home is his castle—something the Fed well understands. Roughly 69% of American families own a home and the median value of that home is approximately $210,000. Another 49% of Americans own stocks directly or indirectly via mutual funds. The median value of that portfolio is approximately $49,000. In our opinion, stock prices move the needle primarily for those in the upper middle class and above. As equity prices move higher, you get a wealth effect within that demographic. For most Americans, however, equity prices do not mean much. To the broader population the one asset they own of any real monetary value is their house. Thus, housing price deflation or inflation has the more significant impact on sentiment and spending. We believe this positive trend in housing will continue and prove supportive to both equity prices and economic growth.

Healthcare Shines

The Fund bested its Russell 2000 Index benchmark by more than two percentage points during the quarter as all sectors within the portfolio and index gained ground. An overweight position and stock selection in Healthcare as well as stock selection in Technology, Industrials, and Materials contributed to the relative outperformance. Medicaid-focused managed care organization Amerigroup soared after it announced that it had agreed to be acquired by health insurer WellPoint. Westlake Chemical stood out within Materials as lower commodity input costs aided an increase in the firm’s margins.

Other notable individual contributors included two Industrials stocks—top-10 holdings Colfax and Corporate Executive Board—as well as tech firm Ixia. Order growth that exceeded expectations and demonstrated good end-market demand boosted the stock of Colfax. The fluid-handling product provider manages a number of leading, premium brands and the firm has expanded into a second business in welding and cutting tools after an acquisition. Corporate Executive Board announced an acquisition expected to accelerate the industry consultant’s growth rate. Ixia provides test systems for network communication providers and reported quarterly results that were ahead of consensus expectations.

Stock selection in the Energy, Financials and Consumer Discretionary sectors detracted from relative performance, while underweights in Technology and Materials were a negative given the strong overall returns in each area. The biggest individual detractor was Coinstar, the operator of automated retail machines best known for its Redbox DVD rental kiosks. The stock slumped on market concerns about the growth at Redbox as well as a difficult third quarter in the face of competition from the Summer Olympics. The stock of energy company Contango Oil & Gas declined on news that its CEO and founder has taken a leave of absence to deal with a medical condition.

Portfolio Positioning

The top three sectors in the Fund at the end of the third quarter remained the same from the prior quarter—Financials, Consumer Discretionary, and Health Care. From a bottom-up perspective, we continue to find these three sectors, and the companies we own in them, the most attractive. From a top-down perspective, all three are highly domestic-facing industries. We think the ongoing recovery in the U.S. economy, aided by the upturn in housing, should prove to be a significant tailwind for these areas going forward.

We increased the portfolio’s position in Financials, as well as Industrials, Technology and Energy during the quarter. Four stocks reached full-position status, including GreenHill & Co., Redwood Trust, and Aruba Networks. Greenhill is an investment advisor that provides clients counsel on Mergers & Acquisitions (M&A), restructuring, and capital raising activities. Since the company does not engage in lending, underwriting, research, or trading, it can offer clients independent, conflict-free advice. Market volatility and tepid M&A activity in 2011 sparked a sharp correction that ultimately provided the portfolio with an attractive entry point. We think as M&A activity rebounds, so will the company’s revenues and earnings. Redwood is a real estate investment trust (REIT) with a sizeable yield that invests in residential mortgage loans and commercial real estate financing that we think should benefit as real estate assets appreciate and demand for mortgage backed securities picks up.

Aruba is a provider of wireless network access hardware and software specifically targeted at the enterprise market. The company is second in market share, and has been gaining share over the past few years by growing revenues by more than 33% in 2010 and nearly 50% in 2011. We believe that the company’s innovative products, designed to satisfy the new bring-your-own device (BYOD) trend in corporate IT, should drive continued market share gains.

We sold four full positions from the portfolio and trimmed a number of others during the quarter, mostly from the Consumer Discretionary, Healthcare, and Materials sectors. After previously mentioned Amerigroup agreed to be acquired we sold the position as a source of funds for other investment opportunities. We parted ways with broadband equipment maker Ceragon Networks at a loss in order to fund better relative opportunities in which we have higher confidence.

Finally, after taking profits in Royal Gold and Westlake Chemical as the market-capitalization for both stocks reached $5 billion, the portfolio ended the quarter with no positions in Materials.  We introduced a holding in the Utilities sector, where the Fund has lacked exposure for a number of years. 

TAMRO Capital Partners
Alexandria, Virginia

As of September 30, 2012, Amerigroup comprised 0.00% of the portfolio's assets, Westlake Chemical – 0.00%, Colfax – 2.86%, Corporate Executive Board – 2.44%, Ixia – 2.17%, Coinstar – 0.98%, Contango Oil & Gas – 1.45%, Greenhill & Co – 1.74%, Redwood Trust – 1.47%, and Aruba Networks – 1.60%.

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.


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