Heartland Opportunistic Value Equity Strategy 1Q16 Portfolio Manager Commentary

 Executive Summary

  • Despite strong stock selection in Information Technology and Utilities, the Strategy lagged its benchmark, the Russell 3000® Value Index, returning -0.33%† versus 1.64%.
  • Mixed economic news led to a volatile start to the year for the Russell 3000® Value Index.
  • We believe macro concerns remain, but the majority of downside risk has already been realized.
  • We’re finding economically sensitive names attractively valued and are taking advantage of oversold conditions tied to Energy and Materials end markets.

First Quarter Market Discussion

Widespread pessimism to start the year gave way to a sense that fears may be overblown. The reassessment helped the major indices reverse broad selling during the first half of the period and close in positive territory.

Solid economic data in mid-February suggested stocks were oversold—even if significant growth wasn’t on the horizon.

The revised outlook led to sharp swings in cyclical areas, as shown. Energy benefited as rig counts and excess production edged lower, and investors concluded oil prices were nearing a bottom. Momentum, which has been a strong factor in performance during the past two years, lagged as investors focused on idiosyncratic catalysts. As sentiment stabilized, investors grew less concerned about balance sheet risk and higher debt companies outpaced low-levered businesses.

Tale of Two Halves

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary Sector Chart

Source: FactSet Research Systems Inc. and Russell®, 1/4/2016 to 3/31/2016.
Past performance does not guarantee future results.

Although views of the market were less negative by the end of the quarter, caution remained. Traditionally defensive areas, such as Utilities and Consumer Staples, were strong performers.

Attribution Analysis

Security selection was mixed. Weakness in our Energy holdings and a stock specific issue in Materials contributed to the portfolio underperforming the Russell 3000® Value Index. An overweight to and stock selection in Information Technology (IT) boosted results. We’ve found attractive values among optical names in the sector that are benefiting from a quest for greater bandwidth by Telecom companies.

A high performer in Technology. IT holding ADTRAN Inc. (ADTN) is an example of a company that has successfully ridden the boom in Telecom spending. The maker of broadband access equipment announced it had won two large contracts and was beginning to see increased demand tied to a government program to bring broadband to rural areas. The appetite for data capacity should persist for the next several years and ADTRAN’s strong balance sheet should position it well to take advantage of growth opportunities or weather unexpected challenges.  

An underweight to Utilities detracted from results, but strong stock selection in the space offset some of the weakness.

A clearer picture. Shares of Exelon Corp. (EXC), an integrated utility, were up as investors sensed natural gas prices were unlikely to go much lower. The stock also got a boost after it received approval from regulators for its plan to acquire a smaller Mid-Atlantic utility. We continue to like the company due to its potential for increased capacity-related revenue, and believe its planned purchase of its peer should provide additional stability to its earnings. While we find the sector generally expensive, Exelon, at 13x expected 2017 earnings, is trading at a discount to regulated utilities and to its 10-year average of 13.7x.

Material pricing pressure. The portfolio’s weakness in Materials was concentrated in one holding. Boise Cascade Co. (BCC), a wood products manufacturer and distributor, was down as the company faced pricing pressure spurred by a glut of imports. Poor demand in Brazil and a strong dollar led to an increase in less expensive foreign product hitting the domestic market. We believe that Boise’s position as the second largest seller of plywood will allow it to weather the surge in competition. While imports may continue to result in significant swings in supply and pricing, at 6x estimated 2016 earnings before interest, taxes, depreciation and amortization (EBITDA), Boise is trading at a steep discount and the valuations should provide downside protection should pricing remain soft.

Portfolio Activity

Our focus continues to be on names with strong balance sheets and those with consistent revenue. The team’s analysis has led to the addition of six names during the past three months. Given that the economy is still in flux, we believe volatile stocks present greater downside risk and have sought to mitigate that factor by holding higher market cap stocks.

Recent addition Exxon Mobil Corporation (XOM) is an example of a larger name that should provide stability but also participate on the upside. The integrated oil and gas company is the largest in the world. It produces approximately 4 million barrels of oil per day and also has a large refining complex along with a chemicals business. The variety of its product lines provides some diversification of revenue. The company’s balance sheet, in our opinion, is particularly attractive. With its AAA rating, Exxon has a significant advantage over other Energy players in securing low interest debt should growth opportunities arise. At 2.2x tangible book value, the company is trading at less than 85% of its long-term average valuation.

Outlook and Positioning

We believe macro concerns remain, but the majority of downside risk has already been realized. Energy will likely continue to have a significant impact on the economy and markets in the near-term; however, we are encouraged by a growing sense of clarity in the sector. The next few months ought to provide greater insight as oil inventories should begin to reflect the continued reduction of active wells and the seasonal volatility tied to spring maintenance at refineries.

The dollar remains strong but we anticipate it is unlikely to continue its aggressive climb. Early signs of mild inflation are encouraging and could provide a lift to cyclically-oriented businesses.

Against this backdrop, we remain focused on valuations and balance sheets. The focus has led to a decrease in exposure to Health Care as valuations have become rich in the face of reduced growth prospects.

For the past few quarters, economically sensitive areas have been attractively valued but we have been cautious due to our belief that prices may not fully reflect additional downside potential. Recent data, in our opinion, suggests things have begun to stabilize and we are taking advantage of the depressed valuations.

While we believe a move into late cyclical companies is prudent, we continue to monitor allocation risk and have structured the portfolio to benefit from idiosyncratic factors identified through the team’s bottom-up analysis.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager David Fondrie

David Fondrie

Fondrie, CPA, is Senior Vice President and Portfolio Manager of the Select Value Fund and its corresponding separately managed account strategy. He has 22 years of industry experience, all at Heartland.

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.

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**9.615.295.406.19-5.53-0.33-0.33
Opportunistic Value Equity Composite (Net of Bundled Fees)7.533.263.344.12-7.39-0.83-0.83
Russell 3000® Value6.395.609.959.08-2.051.641.64

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

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†Composite return is net of advisory fees.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999.
**Provided as supplemental information.

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

In addition to stocks of large companies, the Opportunistic Value Equity Strategy invests in stocks of small- and mid-cap companies that are generally less liquid than large companies. The performance of these holdings generally will increase the volatility of the strategy’s returns.

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 3/31/2016, ADTRAN, Inc., Boise Cascade Company, Exelon Corp, and Exxon Mobil Corporation represented 1.6%, 2.2%, 2.4%, and 3.0% of the Opportunistic Value Equity 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 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.

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

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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.