Heartland Mid Cap Value Strategy 1Q17 Portfolio Manager Commentary

Executive Summary

  • Holdings in Materials and Industrials were strong, but the Strategy lagged its benchmark, the Russell Midcap® Value Index, returning 2.51%† versus 3.76%.
  • Renewed focus on top-line growth was a reversal from the previous several months when valuations drove performance.
  • We believe highly levered businesses have downside potential that is not fully reflected in market prices.

First Quarter Market Discussion

After pushing the major indexes into record territory early in the quarter, investors pivoted to a wait-and-see stance and the markets moved mostly sideways to close out the period. The lack of traction reflected a mixed macro backdrop. Positive economic data and stronger than expected job growth were balanced against political discord in Washington and already elevated valuations for many stocks.

Investors remained generally constructive on equities but hedged some of their bullishness about the economy by favoring growth-oriented businesses and less-volatile names. This renewed focus on top-line increases is a reversal from the previous several months when valuations drove performance. We think this move could be short-lived, with value stocks returning to close the performance gap versus their growth counterparts. As shown, that disparity has been in place for several years.

A Rough Stretch for Value
Russell 3000® Value Index Less Russell 3000® Growth Index

Heartland Mid Cap Value Strategy Portfolio Manager Commentary Value vs Growth Chart

Source: Furey Research Partners and Russell®, 3/31/2010 to 3/31/2017
Additional information for indexes shown at end of commentary.
Past performance does not guarantee future results.

The Federal Reserve Board’s mid-March interest hike was widely expected and viewed as another step on the road to normalized rates. Commentary by the board was viewed as signaling the Fed’s willingness to take a slow and steady approach to tightening. As a result, bond proxies such as Utilities remained steady as investors saw them as a safe place for yield in the near term.

Attribution Analysis

Security selection was mixed, and the Strategy lagged its Russell Midcap® Value Index benchmark. Holdings in Materials and Industrials were strong on both an absolute and relative basis. The portfolio’s Information Technology (IT) names were down moderately on an absolute basis and drove underperformance. Allocation decisions were mostly positive, with a significant underweight to Real Estate boosting results. 

Heartland Advisors materials iconA material contributor. The Strategy’s Materials holdings were a key source of strength with Olin Corporation (OLN), the world’s largest chlor-alkali producer, leading the way. The company continued its impressive run from late 2016. The business has made progress in raising prices for its products, and the industry continues to benefit from expectations for increasing demand and decreasing capacity both domestically and in the European Union (EU).

EU regulations scheduled to take effect this year will require older facilities to cease production of chlor-alkali. The shuttering of plants, we believe, will reduce supply and provide additional pricing strength for Olin.

Heartland Advisors information technology iconWestern woe. IT holdings hurt performance, and the group contained a key detractor. The Western Union Company (WU) was down after it agreed to pay $586 million in fines stemming from an investigation into its anti-money laundering program. The issue was previously disclosed, but the size of the fine was higher than expected and dwarfed the amount the business had set aside to cover the penalty.

The settlement is a serious matter; however, the company began addressing problems when investigators first raised issues and we believe shortcomings have been adequately addressed.

We remain constructive on the name and believe its free cash flow generation will offset additional costs associated with enhanced compliance. Additionally, with the stock trading at 11x earnings per share, investors appear to be overlooking the early traction Western Union has gained from its digital efforts.

Heartland Advisors consumer staples iconAll the right ingredients. Bunge Limited (BG) was a standout in Consumer Staples. The multi-line food and agribusiness company was up after reporting better than expected revenue and earnings. Management also provided a clearer outlook for its core lines as well as its smaller sugar business. The top- and bottom-line growth reflects progress the company has made in cutting costs and focusing its operations.

Management remains committed to selling, spinning off or forming strategic partnerships of its sugar operations, which have an estimated value of as much as $1.5 billion. The company has a robust asset base that should allow it to capitalize on a strong macro environment in agribusiness and food and ingredients.

Portfolio Activity

The Strategy continues to seek high-quality companies as measured by balance sheet strength, free cash flow generating capabilities and returns on capital. Given that much of the late 2016 run up in stocks was driven by expanding valuation multiples, we believe highly levered businesses have downside potential that is not fully reflected in market prices.

Heartland Advisors information technology icon

Banking on tech. Recent addition Diebold Nixdorf, Incorporated (DBD), a banking technology company, is an example of a business with an improved balance sheet and steady cash flow generation that could offer investors attractive compensation for risk. We were early advocates of the name but sold our position in the first half of 2016 as the sales outlook for the U.S. and India became clouded and prospects in China and Brazil were weak.

We continued to believe in the company’s management team, but valuations didn’t adequately reflect the business’ elevated debt or uncertain sales. Since that time, Diebold’s market share abroad has stabilized, cash flow generation is improving and there is greater clarity on progress undertaken to cut costs and improve efficiency following its acquisition last year of a large competitor.  

With balance sheet and sales clarity concerns addressed, we returned to the name and have been encouraged by early signs that Diebold is gaining traction in the high margin areas of its business related to bank branch automation and retail point of sales opportunities.

Outlook and Positioning

Our outlook remains tempered. Market advances appear to have paused as investors look for signs that the economy still has room to grow.

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 the 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.

Composite Returns*

3/31/2017

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Mid Cap Value Composite (Net of Advisory Fees)12.009.6713.759.4228.782.512.51
Russell Midcap® Value10.957.4714.078.9419.823.763.76

Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.

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†Composite returns are net of advisory fees.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1996.

Past performance does not guarantee future results. Performance represents past performance, and current returns may differ.

The Mid Cap Value Strategy invests in mid–sized companies on a value basis. Mid-sized securities generally are more volatile and less liquid than those of larger companies.

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

Heartland Advisors, Inc. (the "Firm") claims compliance with the Global Investment Performance Standards (GIPS®). The Firm is a wholly owned subsidiary of Heartland Holdings, Inc., and is registered with the Securities and Exchange Commission. For a complete list and description of Heartland Advisors composites and/or a presentation that adheres to the GIPS® standards, contact the Institutional Sales Team at Heartland Advisors.

The U.S. dollar is the currency used to express performance.

As of 3/31/2017, Bunge Limited, Diebold Nixdorf, Incorporated, Olin Corporation, and The Western Union Company represented 2.8%, 1.2%, 2.0%, and 2.8% of the Mid Cap Value Composite, respectively.

Statements regarding securities are not recommendations to buy or sell.

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

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.

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

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®.

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

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

Additional Information for Indexes in Chart (calendar year annual returns %):

  2010 2011 2012 2013 2014 2015 2016 YTD 2017*
Russell 3000® Growth Index 17.64 2.18 15.22 34.24 12.44 5.09 7.39 8.63
Russell 3000® Value Index 16.23 -0.10 17.56 32.69 12.69 -4.13 18.40 2.99

*Not annualized as of 3/31/2017
Source: FactSet Research Systems Inc. and Russell® 

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

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

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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