Russell 2000® Value Rebalance: Creating an Expensive House in a Value Neighborhood

Projected Changes to the Russell 2000® Value Index

Weight (%)
Weight (%)
Consumer Discretionary 10.7 9.2 1.5
Consumer Staples 3.0 3.8 -0.8
Energy 5.4 4.5 0.9
Financials 27.9 43.1 -15.2
REITs 13.3 n/a 13.3
Health Care 4.6 4.1 0.5
Industrials 12.1 12.0 0.1
Information Technology 10.4 10.5 -0.1
Materials 4.5 3.9 0.6
Telecommunication Services 0.7 0.9 -0.2
Utilities 7.4 8.0 -0.6
Source: FactSet Research Systems Inc. and Heartland Advisors, Inc.
Projected Weight as of 6/16/2016, Current Weight as of 6/17/2016. Real Estate Investment Trusts (REITs). Rebalancing and breakout of REIT sector expected to take effect at start of trading on 6/27/2016. 

As bottom up investors, the Russell reconstitution’s impact on our approach to managing money is negligible. Yet, while the annual process doesn’t affect our view of individual companies, we monitor the changes to gain insight into ramifications for the market in total.

A significant move this year, as you can see, is the breakout of REITs into a distinct category. For valuation-sensitive investors tied to the Index, the move comes at a challenging time. The trusts have benefited from an insatiable search for yield. We believe rich multiples from too much capital chasing limited opportunities are increasing downside risk. However, a contrarian approach can unearth some overlooked opportunities.

Corrections Corporation of America (CXW), a private prison owner/operator in the REIT space, has been under pressure as investors have grown concerned about the impact of sentencing reforms and presidential campaign trail rhetoric criticizing private prison usage. These concerns are overstated in our view. At 11x estimated 2017 funds from operations versus a peer average of 14x, the full story seems to be overlooked. 

In addition to offering a 6% dividend yield, the company could see margin expansion and increased revenue from renting out existing facilities. Corrections Corporation’s residential rehab initiatives for former prisoners is another potential catalyst that isn’t showing up in the stock’s price.

We believe these are the types of REITs that will receive a closer look from investors tightly constrained to benchmark sector weights and will provide an additional tailwind to some of the businesses we own. We also see it as an example of how fundamental analysis has led us to value opportunities independent of the maneuvers taken by the Index.
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Heartland Advisors Value Investing Portfolio Manager Bradford A. Evans

Bradford A. Evans

Evans, CFA, is Senior Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 21 years of industry experience, 18 at Heartland.

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