A Return to Independent Thinking

 “If everyone is thinking alike, then somebody isn’t thinking.”
― George S. Patton Jr, U.S. General

It’s been a battle for value investors the past several years. Easy Fed policy and macro views have trumped valuations, causing many to hunker down in pricey, low-growth areas. The chase for yield-at-any-cost has tested contrarians like us, and as index funds flows show, many have decided it is easier to go with the masses and give up prospects for outperformance than think for themselves.

However, the challenges have made successes more sweet and each a cause to celebrate. The two-year anniversary of our Mid Cap Value Fund (HRMDX) is an example of a win that deserves notice. We launched the Fund in October 2014* with a straightforward mandate—focus on medium-sized companies and manage it using the same time-tested 10 Principles™ that have defined Heartland since its founding.

We think the results speak for themselves. On a one-year basis, the Fund’s investor class ranks in the 10th percentile by Morningstar out of 466 Mid Cap Value Funds as of 8/31/2016. It has beaten its Russell MidCap® Value Index and continued to perform solidly heading into its second anniversary. The quick start is noteworthy given the Index is loaded with expensive names that have benefited from depressed interest rates. The ability for the Portfolio Management team to produce strong results while staying true to their value roots is impressive!

The success of the Mid Cap Fund is one of several signs that valuations, free cash flow, and quality management may be gaining traction. Performance for the majority of our strategies has rebounded and attractively valued companies in the broader market are beating their growth counterparts. Market breadth is also improving and suggests investors are more willing to take on risk if it is priced right.

Not Everyone Will Win

As fundamentals play a bigger role, passive investors may be in for a rough ride. At 19.4x earnings and 3.3x book value, the S&P 500 seems pricey compared to its historical average. Adding to the nose-bleed valuations is the fact that earnings for the group, as shown, continue to shrink.

S&P 500 Earnings per Share

Heartland Advisors value investing market insight earnings per share chart

Source: Bloomberg L.P. and Standard & Poor’s, 12/31/2012 to 9/30/2016
Chart measures the weighted trailing earnings of index constituents.
Past performance does not guarantee future results.

With declining earnings and rich valuations, we believe investors will cast a wider net in search of opportunities and begin to seek the types of overlooked names we have long been attracted to.

This dynamic could spell trouble for index investors left holding a bag of pricey names with weak earnings. Active managers should fare better by focusing on businesses with growing revenue that are trading at significant discounts to intrinsic value.

Although we are optimistic about the road ahead, the transition to a world where valuations matter won’t be completed overnight. Investors remain guarded as they survey the landscape. Here are just a few concerns they see:

  • Slow gross domestic product (GDP) growth
  • Inflation simmering below the surface
  • Rising employment costs
  • Global and political uncertainty

We share many of the same concerns, yet are encouraged by the number of compelling opportunities out there. Leveraging our thoughtful approach, our bottom-up analysis has helped us unearth niche companies that have unique product offerings or idiosyncratic drivers that should help them thrive regardless of the strength of the broader global economy. We believe this approach syncs well with Patton’s warning about the perils of letting others do the thinking.

We thank you for your continued trust and confidence.

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©2017 Heartland Advisors | 789 N. Water Street, Suite 500, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

Past performance does not guarantee future results.

*The inception date for the Mid Cap Value Fund is 10/31/2014 for the investor and institutional class.

An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

The Mid Cap Value Fund invests in a smaller number of stocks (generally 30 to 60) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns. The Fund also invests in mid–sized companies on a value basis. Mid-sized securities generally are more volatile and less liquid than those of larger companies. There can be no assurance that the Fund will grow to or maintain an economically viable size, in which case the Board of Directors may determine to liquidate the Fund.

There is no assurance that dividend-paying stocks will mitigate volatility.

Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

Investing involves risk, including the potential loss of principal.

There is no guarantee that a particular investment strategy will be successful.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy typically carries a higher risk of loss and potential reward than a value investing strategy. A growth investing strategy emphasizes capital appreciation; a value investing strategy emphasizes investments in companies believed to be undervalued.

The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true.

Economic predictions are based on estimates and are subject to change.

The Percent Rank in Category is the Fund’s total return percentile rank relative to all funds within the same Morningstar Category and is subject to change each month. The Heartland Mid Cap Value Fund investor class was rated against 466 U.S.-domiciled Mid Cap Value Funds over the 1-year period and ranked in the 10th percentile as of 8/31/2016.

Heartland’s investing glossary provides definitions for several terms used on this page.

The Heartland Funds are distributed by ALPS Distributors, Inc.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, Inc.

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