Heartland Mid Cap Value Fund 4Q16 Portfolio Manager Commentary

Executive Summary

  • Stock selection in Consumer Staples and Financials was noteworthy and helped the Fund outperform its benchmark, the Russell Midcap® Value Index, returning 11.86% versus 5.52%.
  • Strength for attractively valued companies continued its year-long trend.
  • We are focused on striking a balance between great companies at moderate discounts and average businesses at deep discounts.

Fourth Quarter Market Discussion

Investor confidence surged following the presidential election and drove the major indexes to new highs. Economic optimism pushed yields up as investors abandoned Treasuries in favor of equities. Meanwhile, U.S. and global credit spreads tightened, underscoring greater confidence and growing comfort toward risk.

An agreement among the Organization of the Petroleum Exporting Countries (OPEC) to cut production also contributed to strength. Investors viewed the supply constraints as a necessary element in a lasting recovery for the Energy sector.

The bullish tone benefited economically sensitive sectors such as Financials, Materials and Industrials the most while defensive areas and so-called bond proxies like Utilities lagged. Across sector lines, attractively valued companies demonstrated strength, as shown, continuing a trend in place for much of the year.

Value Continues to Shine
Russell 3000® Value Index Less Russell 3000® Growth Index

Heartland Mid Cap Value Fund Portfolio Manager Commentary Value Less Growth Chart

Source: Bloomberg L.P. and Russell®, 12/31/2015 to 12/30/2016
Additional information for indexes shown at end of commentary.
All indices are unmanaged. It is not possible to invest in an index.
Past performance does not guarantee future results.

Attribution Analysis

Security selection in the majority of sectors was positive, and the Fund outperformed its Russell Midcap® Value benchmark.

Holdings in Consumer Staples and Financials were noteworthy on both an absolute and relative basis. Allocation decisions were mostly positive, with a significant underweight to Real Estate serving as a key contributor.

Heartland Mid Cap Value Fund portfolio manager commentary Financials iconBeyond the banks. Our Financials holdings outpaced the benchmark and were driven by the Fund’s Insurance names.

CNA Financial Corp. (CNA), a diversified insurance provider, was up after it reported better than expected earnings and continued progress toward winding down or exiting less profitable business lines.

The company brought in an industry executive who is well suited to lead its transformation, and we expect the business will improve its level of return on equity. New leadership is likely to bring experienced producers from a top competitor on board. We also believe management will cut expenses where appropriate.

Despite CNA’s improved underwriting and strong leadership, shares are trading at just 90% of book value. The company’s low dividend payout ratio provides room for dividend growth and/or a one-time special dividend in the future. We believe the multiple doesn’t accurately reflect significant upside potential. 

Heartland Mid Cap Value Fund portfolio manager commentary Materials iconGood chemistry. The Fund’s Materials holdings outpaced the benchmark with Olin Corporation (OLN), the world’s largest chlor-alkali producer, driving the majority of outperformance in the space. The company announced solid earnings and progress on raising prices to consumers. Shares also benefited from expectations for increasing demand and decreasing capacity both domestically and in the European Union. Olin continues to make strides in optimizing its asset base and logistics footprint.

Heartland Mid Cap Value Fund portfolio manager commentary Information Technology iconTechnology glitch. The portfolio’s Information Technology (IT) holdings were up, but the group contained a key detractor.

Top 10 holding CA, Inc. (CA) was down after reporting solid earnings but softer-than-expected new sales in its enterprise solutions business. Shares also faced pressure as investors turned away from slow-growth, cash-producing IT names in favor of economically sensitive areas.

Given CA’s free cash flow to enterprise value yield of almost 8% and a 3.3% dividend yield, we believe investors are overlooking the company’s growth in software as a service (SAAS) sales that are independent of mainframe renewals. The traction in the SAAS business should lead to top-line and earnings growth in the coming quarters.

Portfolio Activity

The Fund continues to hold high-quality companies as measured by balance sheet strength, free cash flow generating capabilities and returns on capital. Given that much of the recent run up in stocks was driven by expanding valuation multiples, earnings growth going forward will be key to supporting current market prices. However, businesses that offer modest growth can still make for profitable investments if they are trading at a significant discount to their historic levels.

Heartland Mid Cap Value Fund portfolio manager commentary Consumer Discretionary iconDiamond in the rough. Recent addition Signet Jewelers Limited (SIG) should see strong bottom-line growth from a combination of increased revenue and greater efficiencies as it digests a recent acquisition.

The company operates under the Jared, Kay, and Zales brands. As the largest jeweler in the U.S., Signet controls approximately 15% of the market compared to 1% or less for peers. This advantage in scale has allowed the company to gain share from small mom-and-pop stores and provides opportunities to reduce costs and improve results. For example, management is focused on increasing sales at its Zales stores by focusing on higher-ticket bridal sets.

Signet is completing a review of its in-store financing business. The analysis could lead the company to divest the business or result in the loans being packaged and sold as securities. In either case, we view the potential move as a positive development.

Heartland Mid Cap Value Fund Portfolio Manager Commentary QuoteOutlook and Positioning

Our outlook has tempered. The markets appear to have entered a transition phase. As economic sentiment has improved, cyclical areas have been rewarded and valuations have expanded. Some of the froth has been removed from more defensive areas, but multiples remain elevated in most cases.

Against this backdrop, we are focused on striking a balance between great companies at moderate discounts and average businesses at deep discounts. Our efforts have resulted in a portfolio with compelling upside that trades at a discount based on valuation multiples we track versus its benchmark, the Russell Midcap® Value Index.

We continue to seek idiosyncratic factors that provide our businesses with the greatest opportunity to succeed. As always, balance sheets are a key focus in our analysis. Companies with favorable liquidity and strong, consistent free cash flow should be in a healthy position to succeed. Additionally, companies that can drive earnings growth—whether through cost savings or increased sales—should be well positioned to keep pace with heightened investor expectations.

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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 15 years of industry experience, 8 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 17 years of industry experience, 13 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 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, 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, CA, Inc., CNA Financial Corporation, Olin Corporation, and Signet Jewelers Limited represented 3.94%, 3.05%, 3.00%, and 1.08% of the Mid Cap 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.

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 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.

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

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy typically carries a higher risk of loss and potential reward than a value investing strategy. A growth investing strategy emphasizes capital appreciation; a value investing strategy emphasizes investments in companies believed to be undervalued.

Dividend paying stocks cannot eliminate the risk of investment losses. Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

Additional Information for Indexes in Chart (monthly returns %):

  12/15 1/16 2/16 3/16 4/16 5/16 6/16 7/16 8/16 9/16 10/16 11/16 12/16
Russell 3000® Growth Index -1.72 -5.97 -0.09 6.81 -0.78 2.00 -0.40 4.86 -0.38 0.45 -2.64 2.67 1.25
Russell 3000® Value Index -2.40 -5.29 0.03 7.29 2.10 1.58 0.83 3.09 0.90 -0.13 -1.68 6.28 2.63


Source: FactSet Research Systems Inc. and Russell®
All indices are unmanaged. It is not possible to invest directly in an inde
x.

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

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

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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.

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