Will the Russell Midcap® Value Index Strike the Right Balance?

Portfolio Manager Colin McWey discusses the key impacts of the Russell Midcap® Value Index rebalance.

Heartland: Will the rebalance affect the advantage that low interest rates have provided the Russell Midcap® Value benchmark?

Colin McWey: The weighting to Energy and Industrials will rise. As a result, the benchmark should benefit from higher inflation than it would have in the past. Before last year’s rebalancing, it was a very disinflationary benchmark.

Frankly, we’ve been finding good companies in the past year that would also benefit in a higher rate scenario. The Index, with its considerable exposure to bond proxies, can still get hurt significantly from interest rate increases. When rates increase, we think investors won’t be willing to continue to pay up for bond-like equities.

Heartland: Beyond the nuts and bolts of sector weightings, how has the Index changed over the years due to rebalancing?

Colin McWey: The Index is no longer as dollar centric. A couple of years ago it was dollar sensitive, which was tough for us because it benefited as the dollar appreciated. We weren’t finding as much value in some of the biggest beneficiaries such as Utilities, Real Estate Investment Trusts (REITs), and Consumer Discretionary as we were elsewhere. To be fair, the dollar weakening in and of itself would not be as bad for the benchmark as it would have been in the past. Energy, commodities, and other inflation driven areas do well with a weaker currency. That has helped offset the fact that REITs enjoy dollar strength. Utilities enjoy a stronger dollar too, but because of low bond yields and low inflation, the group has thrived despite recent dollar weakness.

We’ve been in front of positioning the portfolio appropriately if the dollar bull market comes to an end. We were helped when dollar strength started to break about a year ago, having already been well positioned in compelling opportunities in Energy, Materials, and some Industrials. The result is we are positioned for a weakening dollar, and may be a little bit ahead of the curve.

Heartland: How does the annual rebalancing impact the Team’s approach to managing the Portfolio?

Colin McWey: We’re following a process to uncover and exploit valuation disparities. Investors can’t get that from a rigid Index. If you buy the Index, you could be buying more of what has worked and at higher prices. We’re taking our opportunities and are not constrained by rebalancing.

For example, Energy and inflationary beneficiaries are going up as are Industrials, which coincides with the weak-dollar-inflation discussion. We decided over the past nine months that there were good values in Industrials, so we took our weighting up. The benchmark reconfiguration did not factor into our decision-making process.

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Heartland Advisors Value Investing Portfolio Manager Colin McWey

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 14 years of industry experience, 7 at Heartland.

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Sector rebalancing of the Russell indexes is scheduled to take effect at start of trading on 6/27/2016.

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