*Effective January 1, 2008, the name of the Aston/TAMRO Large Cap Value Fund was changed to the Aston/TAMRO All Cap Fund. Please see the prospectus supplement for addtional information regarding the transition.
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Market Commentary as of 6/30/08
Stagflation
Stagflation is a word created during the late 1970s to describe an economy with high inflation and minimal growth brought about by the rising cost of energy. That word again came to the forefront in June as the price of energy continued its dramatic ascent in the face of a weakening US economy. Stock prices, which had risen strongly in April and May, gave back most of that performance in June. Overall, small- and mid-cap stocks managed to hang on to minor gains for the quarter, while large-cap stocks sank into negative territory. The Fund managed to regain ground against its Russell 3000 Index benchmark after a challenging first quarter.
Many of the stocks that detracted from performance at the beginning of the year bounced back during the second quarter. By early June, the Fund was even approaching a positive absolute year-to-date return before the weakness of the final weeks of June again dropped it into the loss category. Outperformance relative to the benchmark during the second quarter owed primarily to stock selection in the Financials, Consumer Discretionary, and Healthcare sectors. Weak stock selection in Materials and a slight underweight in Energy sector slightly offset this positive attribution. From a market capitalization perspective, an overweight stake in small-caps relative to the benchmark aided performance.
Winners and Losers
The Fund's best performing stocks for the period came from a number of different sectors. Top-10 holding National Oilwell Varco benefited from strength in the Energy sector as well as increased demand for the infrastructure components that it supplies. Corinthian Colleges—one of the biggest detractors from performance during the first quarter—rebounded on reports of continued strong enrollment trends, affirmed guidance from management, and the lifting of fears about the availability of loans to students by recent Congressional legislation. The stock of Anheuser-Busch jumped significantly on a buyout offer from InBev.
Among the portfolio's disappointments were General Electric, Hain Celestial, and Coca-Cola. Disappointing first quarter results and reduced guidance from management pushed GE stock lower. The slowing US economy and difficult capital markets challenged the firm's financial services business, which accounts for roughly 50% of profits. Shares of Hain Celestial dropped on fears that strapped consumers may shy away from natural and organic products to help reduce the sting of rising food prices. Coca-Cola struggled owing to concerns about weak revenue growth heightened by a warning from an East European bottler and the anemic US economy.
Buys and Sells
During the quarter, we added several new positions to the Fund in companies with dominant global franchises. A quarterly miss amid high expectations, a weakening consumer environment, and concerns on its ability to monetize YouTube drove shares of Google to four-year lows, presenting an attractive buying opportunity. The company's innovative culture—driven by its two co-founders—continues to dominate the search-based advertising business, and has plenty of experience and room to invest for future growth. The shares of technology stalwart IBM corrected on fears of a slowdown in tech spending, but with the company's improved product portfolio and 63% of revenues coming from outside of the US, we believe it is poised to weather an economic slowdown.
Philip Morris International and Starbucks are two other new purchases with broad global reaches. Philip Morris International, the overseas tobacco unit of Altria Group, split off from its parent at the end of March. Although tobacco volume is declining in most developed markets, the business continues to maintain substantial pricing power that helps it to maintain profitability. More importantly, management is working on becoming a more meaningful player in developing markets, especially in China, India, Bangladesh, and Vietnam—countries that represent 40% of international tobacco consumption—where it doesn’t have a significant presence. Starbucks has struggled considerably after years of aggressive and successful unit growth that drove outsized returns. The firm stands to benefit from significant growth potential overseas, but we view the return of Howard Schultz, the architect of the company's successful growth, as the main attraction. We think Mr. Schultz is taking aggressive and appropriate steps to improve the customer experience and shutter non-core parts of the business.
The most controversial addition to the portfolio is likely SLM (formerly known as Sallie Mae), the leading provider of saving and paying-for-college programs. A failed buy-out of the company, along with dislocations in the credit markets that led to a spike in the firm's borrowing costs, led to a dramatic decline in the stock's price. Beyond valuation and an efficient business model, we were attracted to Sallie Mae based on the favorable industry trends in higher education (including ongoing cost inflation), actions by the government to increase liquidity in student lending, and the hiring of a number of outsiders with experience in turning around lagging financial services firms.
The fund sold 10 full positions during the quarter. Along with Anheuser-Busch, WM. Wrigley and Activision received buyout offers, and all were sold near their target prices. We sold long-time holding McDonald's due to valuation, after it executed extremely well. Industry challenges were the primary reason for the sales of Legg Mason, Southwest Airlines, and Walgreen. Finally, Merck was sold due to concerns about its product pipeline as well as our desire to reduce exposure to pharmaceuticals and reinvest in health-care information technology firms.
Outlook
Looking ahead it is difficult to discern whether the recent reversal in market-cap sentiment that lifted the Russell 2000 Index above large-cap stock indexes during the quarter is a sign of a long-term change in trend. Global economies are currently stronger than the US, which favors larger firms with a global reach, but rising commodity costs and dampened domestic demand for imports other than energy could bring parity to global economic growth. The fear of higher inflation (financial assets' worst enemy) has neutralized improvements in valuation. Near-term, neither monetary nor fiscal policy options will likely change sentiment. The most significant event needed to bring about a positive course would be a downward shift in energy and other commodity prices brought about by slowing world economies or a geopolitical resolution to Iran, neither of which is predictable, though valuation tilts in favor of giving that outcome a higher probability.
Portfolio positioning during the quarter reflects a slight shift in this direction. We took profits in more commodity-oriented firms within the Energy sector and redeployed those assets into infrastructure (Willbros Group) and refining (Valero Energy). The change is more about valuation and market-cap constraints than in our prowess to forecast macro events. In addition, our traceable increase towards the consumer reflects a better balance between fundamentals and valuation that we observed initially in our quantitative model. We are gradualists by nature, and always cognizant that the economic headwinds tend to blow fiercer than presumed.
TAMRO Capital Partners
Alexandria, Virginia
As of June 30, 2008 National Oilwell Varco comprised 2.84% of the portfolio's assets, Corinthian Colleges - 2.01%,General Electric - 0.82%, Hain Celestial - 2.10%, Coca-Cola - 2.32%, Google - 1.98%, International Business Machines(IBM) - 1.79%, Philip Morris International - 1.58%, Starbucks - 1.58%, SLM -1.41 %, Willbros Group - 2.58%, and Valero Energy - 1.77% .
Note: Value investing involves buying company stocks that are out of favor and/or undervalued. Depending on market conditions, a fund's return may be adversely affected during market downturns.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed. Holdings and weightings are subject to change daily. Holdings are provided for informational purposes only and should not be construed as a recommendation to buy or sell the securities mentioned.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.