Q&A: A Sweet Spot for Investing

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Presenters

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He also is CEO of Heartland Funds. He has 17 years of industry experience, 13 at Heartland.

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He has 15 years of industry experience, 8 at Heartland.

Transcript

Nasgovitz: Hi, thanks for tuning into the final installment of the Nasgovitz Notes here in 2016. We’ve certainly enjoyed taking the time to provide our insight on a couple capital market and economic-related themes over the course of this year.

Today though, in this video, we’re going to change gears a little bit and talk about our youngest product here at Heartland Advisors.

The Heartland Mid Cap Value Fund just celebrated its two year anniversary, and today with me I have Colin McWey. Colin is the leading manager on the strategy. He’s been with us since 2009. Welcome, Colin.

Colin, I thought to start, let’s keep it at a high level. Why should investors have exposure to mid-caps?

McWey: If you look historically and just compared small versus large for a second, you would see that small-caps provide higher long-term returns than large-cap stocks. However, at times small-caps can provide a little bit more volatility to your portfolio. Mid-caps have provided some of the best of both worlds where, over very long periods of time, mid-caps have provided returns that look a little bit more like small-caps, however a volatility profile that looks a little bit more like large-caps.

Nasgovitz: Interesting. Some compelling attributes for the asset class. Give us some perspective on how you make your investment decisions.

McWey: Sure. We use the same 10-point, bottom-up investment process that Heartland has since its inception. So, it’s a traditional value style. The preferred valuation metrics are price-to-earnings ratio, price-to-cash-flow ratio, price-to-book ratio.

We are extremely focused on style purity, and the upshot of that over the last several years is you would find that our portfolio carries significant discounts to not only the broad market, but our benchmark on these metrics.

Portfolio is Attractively Valued vs. Benchmark & the Market

Heartland Mid Cap Value Fund Valuation Metrics

*Weighted average
Equity securities only, weighted median unless otherwise noted
As of 10/31/2016
Index source: FactSet Research Systems Inc. and Russell®

At the same time we have a qualitative process at Heartland, too. That looks at the financial soundness of a company, so we really look at the credit metrics, the leverage of the company's balance sheet. And you would see that our holdings, over time, also carry less debt than the typical stock in our benchmark.

Portfolio also has Less Debt

Heartland Mid Cap Value Fund Debt Comparision Chart

As of 10/31/2016
Index source: FactSet Research Systems Inc. and Russell®

We also have a qualitative aspect focused on the business strategy of the company, the industry structure that the company operates in, the company’s key objectives to change the market’s current perception about it in the future. We do a rigorous assessment of a company's management team. Are they shareholder friendly or not? Do they have a proven track record of value creation?

We put this all together and what we’re really trying to do with the 10 Principles™ is essentially identify the opportunity for value stocks—which currently in many cases carry below-market valuations—to change the market’s perception at some point in the future.

Nasgovitz: So, it’s a good balance of the art and the science.

An area of interest for the Mid Cap Fund over the last year—or at least growing interest—has been Energy. The Energy complex has been under pressure as oil prices went down meaningfully starting about two years ago. What about Energy is so interesting today?

McWey: Look, at Heartland we love to invest counter-cyclically when we can get our hands on great companies with good balance sheets and a strong history of returns on invested capital.

And in those scenarios, even if the current returns or the current profitability is temporarily depressed, we’re willing to look at what a company has done over cycles.

And what we were able to do, we think, is get ourselves significant long-term upside with value creating companies, industry leaders with a low cost structure or a balance sheet advantage or some sort of technological differentiation.

But the only way that you can do that is if you step into a big bad bear market, and anyone who's followed financial markets over the last several years, point to one area of the market that has had a harder time than Energy.

Nasgovitz: So, there’s still some opportunities in that space. We are several years into this economic expansion, several years into this bull market off the March 2009 lows. Are you still able to find opportunities outside the Energy patch that are of interest today?

McWey: Yes we are. Over the past year-and-a-half, we've positioned the portfolio to be a little bit more, I’d call it late cycle. By late cycle, we touched on Energy, but I’d also touch on Industrials. We added to Industrials meaningfully over the past 12 to 18 months, especially when recessionary fears percolated earlier this year.

You look at the holdings we've added, and you look at the historical value creation of these companies as they’ve essentially won out and consolidated their industries and become market leaders.

Once again, you need a little bit of fear in those spaces to be able to buy them at the attractive prices where we did.

Nasgovitz: That’s a great recap, Colin. Congratulations on the great two-year track record.

If you want to learn more about the Heartland Mid Cap Value Fund, please check out our website. Thanks for tuning into this video.

We look forward to updating you with future Nasgovitz Notes in 2017. Take care.

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