Heartland Mid Cap Value Fund 2Q16 Portfolio Manager Commentary

Talking Points

  • Stock selection in Industrials and Materials was strong and helped the Fund outperform its benchmark, the Russell Midcap® Value Index, returning 6.24% versus 4.77%.
  • Weakening currency and higher oil prices dampened concerns of deflation in the U.S.
  • Upgrades to our holdings should result in a portfolio that is positioned for a late cycle environment and may offset volatility if growth stalls.
  • In this unsettled economy, we are targeting companies with the financial strength to fund expansion in a growth environment or provide a cushion in a downturn.

Second Quarter Market Discussion

The quarter marked another step in a rotation away from the market being dominated by dollar strength and deflation concerns. The move was helped by a dollar that was volatile yet generally weaker than at the start of the quarter as well as higher oil and commodity prices. As the prevailing themes continued to fade, investors grew comfortable owning businesses with international exposure. Market breadth reflected a willingness to cast a wider net as demonstrated by eight of 10 sectors posting positive returns in the Russell Midcap® Value Index.

Late stage cyclical areas were among the biggest beneficiaries of a growing comfort to risk assets. Economically sensitive names were rewarded to varying degrees based on whether they were helped by currency weakness. As you can see, the dollar softened for most of the quarter before snapping back in response to the United Kingdom’s vote to leave the European Union. The softening boosted dollar-priced commodities and businesses that derive a portion of revenues abroad. Cyclical groups such as Consumer Discretionary, where strong domestic currency and low inflation serves as a tailwind, lagged.

Dollar Declining Vs. World Currencies

Heartland Mid Cap Value Fund Portfolio Manager Commentary Dollar Chart

Source: FactSet Research Systems Inc., 12/31/2015 to 6/30/2016
Past performance does not guarantee future results.

Attribution Analysis

The rotation to previously shunned economically sensitive areas was welcome news for valuation conscious investors. During the past 12 months, we have consistently found compelling valuations among these groups and our commitment was rewarded as the Fund outperformed its Russell Midcap® Value benchmark. The Fund's investor class was ranked by Morningstar in the 25th percentile out of 470 Mid Cap Value Funds for the 1-year period as of 6/30/2016.

Security selection in Industrials and Materials helped returns.  A company specific issue was responsible for the Portfolio’s negative absolute performance in Consumer Discretionary.

A material benefit. Among names in Materials, Olin Corp. (OLN), the world’s largest chlor-alkali producer, was a standout. Shares were up sharply on the back of an announcement the company was reducing production in North America. This news, along with further signs of upcoming output cuts from competing European and North American facilities, should result in tighter supply and improved pricing.

Investors initially cheered the acquisition of a competitor last year; however, as credit markets softened, souring on the use of debt to finance the deal set in. We continued to meet with management who believes there exists a multi-year window of a favorable supply/demand balance. Those discussions along with additional analysis, including stress testing free cash flow projections under various scenarios, led us to add to our position.

Despite the recent run up, the company is trading at 7.5x enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA). It is possible the valuation could go down even further as benefits from the acquisition are realized.

A Utility player. While Utilities has been a beneficiary of the scramble for yield in light of the Fed’s low rate policies, we believe many regulated power companies are generally expensive with weak prospects for increased revenue. Our research has led us to compelling opportunities among partially regulated players. MDU Resources Group, Inc. (MDU), a utility with construction, pipeline and energy services business lines, fits the mold. The company reported solid earnings this quarter helped by recently approved rate increases. Backlogs for its construction services and materials units also grew considerably during the period, and it is anticipated the aggregate business could see improved margins. Trading at a 20% discount to our sum-of-the-parts analysis, we believe MDU’s diversified business model provides multiple avenues for continued growth.

Not in the shopping mood. The Portfolio’s weakness in Consumer Discretionary was primarily tied to one holding. National department store Kohl’s Corp. (KSS) was down after reporting declining year-over-year sales, which management attributed to poor weather. The company also acknowledged that efforts to enhance online sales ate too deeply into its conventional marketing budget. While we were disappointed in the results, we are encouraged by the arrival of a new Chief Operating Officer, a renewed sense of urgency, and its maintained guidance for the full year.

Kohl’s faces pressure—like many retailers—from the dominance of Amazon.com, Inc. (AMZN). However, the company is trading at its lowest level in a decade as measured by price-to-book, EV/EBITDA, and price-to-earnings. At these significantly depressed levels, even modest improvements in sales should result in a sizeable move for the stock.

Financially sound. Stock selection in Financials was additive. The majority of holdings in the space performed positively; insurers contributed the most on a relative basis.

Obstructed view. An overweight to Information Technology dampened results and the group contained a key detractor. A banking technology company was down after it reported weak earnings, depressed cash flows, and a rise in inventories. The company also said the sales outlook for the U.S. and India was clouded and prospects in China and Brazil were weak.

Unlike Olin, where we bought on weakness due to a clear, constructive outlook, we exited our position in the technology company because its debt levels made us uncomfortable. We still believe the company is led by a management team that has success in improving operations and product offerings, but believe its risk reward profile is no longer compelling. 

Portfolio Activity

We continue to take volatility as an opportunity to upgrade the quality of our holdings. Facing a tighter lending environment, we remain cognizant of debt levels on an absolute basis and relative to free cash flow. Given companies with stronger credit ratings will likely have greater flexibility when pursing growth, we are also focused on credit market dynamics and how they affect the rates companies needing to raise capital will pay.

Economically sensitive names that tend to fare well in the later stages of expansion have caught our attention. As a result of our belief that inflation could hamper consumer-oriented businesses that lack pricing power, we’ve adjusted our exposure away from mall-based retail businesses. Similarly, low interest rates and depressed gas prices have provided a tailwind for Main Street. It is unlikely these benefits will persist in a way that warrants the elevated valuations in some pockets of consumer-oriented industries.

Outlook and Positioning

The economy appears to be reaching a crossroads. We think there are an array of possible outcomes in the coming months ranging from stagflation to a resurgence of value-oriented sectors brought on by a weakening dollar, rising commodity prices, and continued slow growth. While we believe the most likely outcome is modest inflation and economic growth, we remain focused on idiosyncratic factors that provide our businesses with the greatest opportunity to succeed. Balance sheets will matter in the months ahead. Companies with favorable liquidity and strong, consistent free cash flow should be in a healthy position to succeed regardless of the macro environment. Additionally, valuations will continue to be important, and we believe paying up for traditionally defensive sectors heightens downside risk.

Against this backdrop, we are being conservative when analyzing projected earnings and are focused on financial strength that can be drawn upon to either expand in an environment of economic growth or to use as a cushion should the economy falter.

Thank you for the opportunity to manage your capital.

Please wait while we gather your results.

Portfolio Management Team

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.

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

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 16 years of industry experience, 13 at Heartland.

Email Sign Up

  • I am a financial professional or institutional investor
  • I am an individual investor
Financial Professionals & Institutional Investors
Individual Investors

Name

Email

 

Heartland Perspectives

Heartland Perspectives


Product Insights

Select Value Fund

Mid Cap Value Fund

Value Plus Fund

Value Fund

International Value Fund

Opportunistic Value Equity Strategy

Mid Cap Value Strategy

Small Cap Value Plus Strategy

Small Cap Value Strategy

Terms of Use
These email lists are created for use by U.S. investment professionals only and are published strictly for informational purposes. Providing access to the content of these emails does not explicitly or implicitly constitute a solicitation of services or products of Heartland Advisors, Heartland Funds, or any of their affiliates. The information contained in these emails is not intended for distribution to, or for use by, investment professionals in a jurisdiction where distribution or purchase is not authorized. The information contained in these emails is not appropriate for use by individual investors. By registering for any of these emails, you agree to Heartland’s terms and conditions and that you are qualified as an institutional investor or otherwise member of a registered broker/dealer, registered investment advisor, or investment consulting firm.
I agree to the Terms of Use and confirm that I am a financial professional

Monthly enews

©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

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 Mid Cap 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 3.22% for the investor class shares and 3.46% 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 6/30/2016, Amazon.com, Inc., Kohls Corp., MDU Resources Group, Inc., and Olin Corp., represented 0.00%, 1.08%, 4.13%, and 4.39% of the Mid Cap Value Fund’s 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.

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 guarantee that a particular investment strategy will be successful.

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 470 U.S.-domiciled Mid Cap Value Funds over the 1-year period and ranked in the 25th percentile.

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.

The Mid Cap Value Fund seeks long–term capital appreciation and modest current income.

The ICE U.S. Dollar Index (USDX) futures contract is a leading benchmark for the international value of the U.S. dollar and the world's most widely-recognized traded currency index. In a single transaction, the USDX enables market participants to monitor moves in the value of the U.S. dollar relative to a basket of world currencies, as well as hedge their portfolios against the risk of a move in the dollar. U.S. Dollar Index futures are traded for 21 hours a day on the ICE platform.

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

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.

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.

top