Heartland International Value Fund 4Q16 Portfolio Manager Commentary

Executive Summary

  • Security selection was positive with names in the majority of sectors helping the portfolio outperform the Russell Global® ex-US Small Cap Index, returning -0.90% versus -3.61%.
  • Australia was a source of strength, followed by names in the United Kingdom and Brazil.
  • Valuations for international small cap stocks are at a 20-year low versus domestic stocks.

Fourth Quarter Market Discussion

The relative calm of the third quarter gave way to a new wave of volatility in global markets. Currency movements, ongoing concerns about Brexit fallout, and a surprise result in the U.S presidential election injected uncertainty, and international equities were under pressure.

Investors largely viewed Donald Trump’s victory as bullish for the U.S. economy and adopted a risk-on stance in response. As a result, the Yen weakened and Japanese exporters in Industrials benefited. A stronger U.S. dollar put pressure on Emerging Markets, but some of the weakness was offset by firmer energy prices. The overhang from the expected economic split by the United Kingdom (UK) from the European Union created headwinds and UK stocks lagged.

Attribution Analysis

Security selection was positive on a relative basis with names in the majority of sectors helping the portfolio outperform the Russell Global® ex-US Small Cap Index. The Fund’s holdings in Real Estate and Consumer Staples led the way higher. A stock-specific issue in Health Care was the primary detractor to relative and absolute performance.

On a regional basis, holdings in Australia were top contributors, followed by names in the United Kingdom and Brazil.

Heartland International Value Fund portfolio manager commentary Materials iconA boom in free cash flow? Holdings in Materials were down modestly on an absolute basis but outpaced the benchmark, and the group contained a top contributor. Incitec Pivot Limited (IPL AU), an Australia-based leader in explosives and a well–established producer of fertilizer, was a top performer after the company began operations in its newly completed ammonia plant located in Louisiana.

This new facility was completed under budget and allows the company to take advantage of inexpensive North American natural gas in the ammonia production process.

The plant should mark the end of an eight-year capital expenditure cycle. As the company’s investment needs ebb, we expect free cash flow will surge. The additional funds could be used to repurchase shares or will help the business weather soft demand in the future.

Additionally, management’s cost-cutting initiatives have been effective, and we expect margins will lead to upside earnings surprises as product prices recover from tepid demand in farming and mining.

Heartland International Value Fund portfolio manager commentary Industrials iconGoing on defense. Industrial holding Chemring Group PLC (CHG LN) boosted results. The supplier of flares, sensors, and electronics in the Defense industry was up due to a combination of currency and geopolitical developments.

Weakness in the British pound spurred by Brexit concerns benefited the UK-based company as its products should be more competitively priced compared to those from countries with stronger currencies. Results from the U.S. elections were also viewed by investors as constructive for defense spending as a whole, with Chemring being rewarded along with other players in the space.

A stock offering in the beginning of 2016 helped bolster the company’s balance sheet, and we have been pleased by its consistency in meeting earnings expectations for the past several quarters. Trading at 1.1x book value, Chemring is priced at a discount to its long-term historical average and at the lower end of its five-year range.

Heartland International Value Fund portfolio manager commentary Health Care iconMisdiagnosed. Trinity Biotech PLC (TRIB), a developer and manufacturer of diagnostic products, fits our strategy of holding businesses with competitive advantages that should allow them to grow faster than peers. The stock was down sharply after pulling its bid for Federal Drug Administration (FDA) approval of a rapid test used for detection of heart attacks in emergency room settings. The test showed promising results, but the company rescinded its application based on an FDA recommendation.

The decision was a major disappointment, but the market’s reaction, in our view, is overblown. Trinity remains a premier diagnostics company in diabetes testing. Trinity is also a key player in the HIV rapid test diagnostic market in Africa and controls a third of the segment in the U.S. The company’s infectious disease line generates $43 million in annual sales—equal to about one-quarter of the Dublin-based business’ market cap.

Portfolio Activity

Japanese Industrials reaped the rewards of a depreciating Yen in recent months. We’ve trimmed on the strength and our overweight to the country has essentially been erased. The move reflects our approach of harvesting gains to mitigate risk and not a sign of negative sentiment in the area.

Conversely, weakness in the UK has resulted in several names hitting our watch list and we have added companies opportunistically.

Outlook and Positioning

The volatility that dominated global markets for much of 2016 should persist into the first half of the year. Fallout from the Brexit vote remains on the horizon as does the impact of a new administration in the U.S. Questions about the strength of European banks is an additional wildcard that could have a material effect on the economy as well as equities.

We cannot control macro factors but, as bottom-up investors, we can capitalize on the opportunities that emerge in response to external events. As the chart shows, the performance gap between international and domestic stocks is wider than it’s been in the past 20 years. Additionally, valuations for international stocks remain significantly more attractive than U.S. stocks.  We view the discrepancy as an opportunity to own a portfolio of businesses trading at compelling valuations that is diverse by region, sector, and industry.

Time for a Reversal?

Heartland International Value Fund Portfolio Manager Commentary US vs Global Chart

Source: Bloomberg L.P., Russell®, and Heartland Advisors, Inc., 7/31/1996 to 12/30/2016
Economic predictions are based on estimates and subject to change.
Past performance does not guarantee future results.

Japan remains attractive from a long-term perspective, but strength in economically sensitive areas has made bargain hunting more challenging. While Developed Europe remains fertile ground for investment ideas we are also seeing opportunities in Emerging Markets such as Brazil.

We are comfortable with our Emerging Market holdings, but believe political headwinds and inflationary pressures require heightened attention when evaluating companies in the group.

Our focus remains on finding sound businesses with strong management teams that have a history of prudent capital allocation decisions. We believe owning dividend-paying companies with robust balance sheets provides downside protection while allowing for upside potential.

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Michael Jolin

Michael Jolin

Jolin, CFA, is Vice President and Portfolio Manager for the Heartland International Value Fund. He has 13 years of industry experience, 7 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Robert Sharpe

Robert C. Sharpe

Sharpe is Vice President and Portfolio Manager of the International Value Fund. He has 33 years of industry experience, 3 at Heartland.

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In the prospectus (pdf) dated 5/1/2017, the Total Annual Fund Operating Expenses After Fee Waiver and/or Expense Reimbursement for the investor and institutional classes of the International Value Fund are 1.25% and 0.99%, respectively. The Advisor has contractually agreed to waive its management fees and/or reimburse expenses of the Fund to ensure that Total Annual Fund Operating Expenses for the Fund do not exceed 1.25% of the Fund’s average net assets for the investor class shares and 0.99% for the institutional class shares, through at least 5/1/2019, and subject thereafter to annual reapproval of the agreement by the Board of Directors. Without such waiver and/or reimbursements, the total annual fund operating expenses would be 1.89% for the investor class shares and 1.63% for the institutional class shares.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days (90 days for the International Value Fund) of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual's return.

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.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

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. The specific securities discussed above, which are intended to illustrate the advisor’s investment style, do not represent all of the securities purchased, sold, or recommended by the advisor for client accounts, and the reader should not assume that an investment in these securities was or would be profitable in the future. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Any forecasts may not prove to be true.

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

As of 12/31/2016, Chemring Group PLC, Incitec Pivot Limited, and Trinity Biotech PLC represented 3.14%, 3.99%, and 1.48% of the International Value Fund’s adjusted net assets, respectively.

Portfolio holdings are subject to change without notice. Current and future portfolio holdings are subject to risk.

Sector and industry classifications as determined by Heartland Advisors may reference data from sources such as FactSet Research Systems, Inc. or the Global Industry Classification Codes (GICS) developed by Standard & Poor’s and Morgan Stanley Capital International.

Foreign country classifications are generally determined by referencing country of domicile sourced from FactSet Research Systems Inc.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

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

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

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

The International Value Fund invests primarily in small foreign companies selected on a value basis. Such securities generally are more volatile and less liquid than those of larger companies. Foreign securities have additional risk, including but not limited to exchange rate changes, political and economic upheaval, and relatively low market liquidity. These risks are magnified in emerging markets.

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

The above individuals are registered representatives of ALPS Distributors, Inc.

CFA® is a registered trademark owned by the CFA Institute.

The Heartland Funds are distributed by ALPS Distributors, Inc.

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