Heartland Value Plus Fund 3Q16 Portfolio Manager Commentary

Executive Summary

  • Strong performance by holdings in several sectors couldn’t overcome weakness in Consumer Staples and Real Estate, and the Fund lagged its benchmark, the Russell 2000® Value Index, returning 6.95% versus 8.87%.
  • Central bank policies appear to have lost their impact, leaving consumers and businesses hesitant to spend.
  • Our focus remains on balance sheet strength and margin expansion opportunities.
  • The economic picture remains muddled and volatility could persist.

Third Quarter Market Discussion

The quarter ended as it started with contradicting economic data and mixed messages from the Federal Reserve on if or when it would nudge rates higher. A contentious election at home and economic and political challenges globally added to the murky outlook.

Many consumers and businesses reacted by sitting on the sidelines waiting for a consensus view of the economy’s strength to emerge. Retail sales growth, as shown, continued to soften and growth in consumer spending was on track to slow to just 3% during the quarter.

Retail Sales Slowing

Heartland Value Plus Fund Portfolio Manager Commentary Retail Sales Chart

Source: Cornerstone Macro LP, 12/31/2010 to 9/30/2016
*Estimates as of 9/28/2016 are used for the quarter ended 9/30/2016
Series measures real retail and food services sales in millions of chained 2009 dollars

Despite the subdued mood by companies and households, investors continued to bid up stocks in hopes that the economy would grind on for the remainder of the year before accelerating in 2017. This hopeful outlook was reflected in strong performance among economically sensitive areas of the market with Industrials and Materials among the top performers.

Attribution Analysis

Security selection in several sectors was positive on an absolute basis, but weakness in Consumer Staples and Real Estate caused the Fund to lag its benchmark, the Russell 2000® Value Index. An overweight to and strong selection in Information Technology (IT) boosted results. The Fund’s holdings in Energy were also key contributors. Allocation decisions yielded mixed results: underweights to Utilities and Real Estate boosted performance, while an underweight to Financials detracted.

Heartland Advisors health care iconA good draw. Haemonetics Corporation (HAE), a provider of products used in the processing, handling and analysis of blood, was a strong contributor. The company was up after it beat analysts’ estimates for revenue and reiterated guidance for the full year. The name fits with our goal of finding businesses that can improve bottom line results through internally focused efforts.

Management has been aggressively slashing costs and repositioning sales efforts toward its plasma and diagnostic instrument business lines that generate more than 45% gross profit margins. We think the new approach is prudent and have been impressed with the progress so far. Trading at 9x enterprise value (EV) to estimated 2017 earnings before interest, taxes, depreciation and amortization (EBITDA), and with a solid balance sheet, we believe the risk-reward profile is compelling.

Heartland Advisors financials iconBanking on improved margins. Financials detracted on a relative basis, however, our Bank holdings were strong. Zions Bancorporation (ZION), is an example of the type of name we found attractive. The stock traded higher as Zions’ book of loans with Energy exposure performed better than expected. The regional bank has also made faster-than-expected progress on improving efficiency and is pursuing fee generating opportunities.

The company trades at 1x tangible book value despite its premium core deposit base. The discount, in our view, doesn’t fully reflect greater revenue opportunities and the cost-cutting efforts underway. These initiatives should result in a greater efficiency ratio and an improved return on equity.

A stock specific issue in the Real Estate Investment Trusts industry accounted for the majority of weakness in Real Estate. Our Materials holdings performed well on an absolute and relative basis. Names in the Metals and Mining Industry were the primary drivers, but we are finding opportunities in multiple parts of the sector.

Heartland Advisors materials iconThe value of good ingredients. Innophos Holdings Inc. (IPHS), a mineral-based special ingredients company, should be able to continue to improve margins under a plan introduced by new management. The approach calls for aggressive cost cutting, reduction of inventory and debt, and repositioning the company to focus on higher profit margin products.

Revenues were down for the most recent quarter, but earnings beat analysts’ estimates, reflecting the positive impact of some of management’s new initiatives. We believe the cost-cutting efforts along with a more aggressive marketing plan should allow margins to increase and sales to expand. Trading at less than 7x EV to 2017 estimated EBITDA, we believe the market is not fully appreciating Innophos’ upside.

Portfolio Activity

Against an uncertain economic outlook, we continue to focus on businesses that can (1) generate margin expansion through self-help, (2) are prudent allocators of capital, and (3) have low debt. We are avoiding businesses we expect will undertake significant capital expenditures in the near-term and are moving away from those that are reliant on cyclical growth.

Companies with opportunities to reduce costs and improve margins should be able to grow earnings in a flat economy or will be well positioned should the climate improve. Heightened volatility has allowed us to add positions opportunistically as prices warrant.

Outlook and Positioning

The global economic picture remains muddled. Central bank policies appear to have lost their effectiveness, and businesses and consumers are hesitant to spend. Against this backdrop, market uncertainty could persist for the next several months. Inflation is starting to creep up and could force the Fed to abandon its commitment to historically low interest rates.

Instead of making a call on how the macro environment will unfold, we are focusing on owning businesses with multiple levers management can pull to improve results and increase margins. Self-help opportunities that are particularly attractive against the current backdrop include:

  • Facility consolidation
  • Reducing overhead expenses
  • Divesting or discontinuing less profitable product lines
  • Capitalizing on pricing power
  • Focused investment in profitable growth opportunities

Additionally, we want to own businesses that have strong balance sheets and that will employ solid capital allocation strategies. Companies that can drive operational improvements regardless of the macro backdrop should produce solid results in multiple environments and be recognized by the markets.

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

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.

Heartland Advisors Value Investing Research Analyst Andrew Fleming

Andrew J. Fleming

Fleming, CFA, is Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 8 years of industry experience, 5 at Heartland.

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In the prospectus (pdf) dated 5/1/2017, the gross expense ratios for the investor and institutional class of the Value Plus Fund are 1.19% and 0.97%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/reimbursement may be discontinued at any time. Without such waivers and/or reimbursements, total returns may have been lower.

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 9/30/2016, Haemonetics Corporation, Zions Bancorporation, and Innophos Holdings Inc. represented 2.43%, 2.08%, and 2.24% of the Value Plus 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 assurance that dividend-paying stocks will mitigate volatility.

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

The Value Plus Fund invests in small companies that are generally less liquid and more volatile than large companies. The Fund also invests in a smaller number of stocks (generally 40 to 70) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns.

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

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

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

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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