Follow at Your Own Risk

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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 18 years of industry experience, 14 at Heartland.

Transcript

The momentum in passive certainly has accelerated this year. 
 
It's very much on display when you look at the flow data into sector ETFs. 
 
Technology really stands out. Technology-related ETFs have seen something like $3.5 billion of inflows this year. $3.5 billion isn’t a huge sum when you think about the broader capital markets, but when you compare where those assets and the strategies were at the beginning of the year—it was just about $30 billion—so north of a 10% uptick in those in those assets just this year.
 
Technology ETF Cumulative Flows
Heartland Advisors Value Investing ETF Chart
Source: Jefferies and FactSet Research Systems Inc., 1/3/2017 to 11/29/2017
Technology ETF Flows are represented by equal weights of: Technology Select Sector SPDR, Vanguard Information Technology ETF, First Trust Dow Jones Internet Index, iShares US Technology ETF. Exchange Traded Fund (ETF).
 
We take the view, when you see this herding into one particular strategy, that the risk profile gets elevated.
 
We’re also mindful of what investors are not doing. 
 
So, back to the flow data for ETFs—sector ETFs that is—investors have been selling, redeeming, Utility-related strategies. We think that's interesting. It has become an unpopular area to be in the marketplace.
 
It’s not that surprising to us, I guess, that investors are selling Utility-related ETFs. 
 
They’re not screening great. What we mean by that is that valuations for the group aren't super attractive. The price-to-earnings ratios are elevated. The growth outlook isn't super attractive either; It’s not a very robust growth outlook.
 
That being said, when we think about how unpopular the group has become, we as active investors want to unearth some attractive opportunities. 
 
In our portfolio today, the vast majority of our Utility stocks trade at a discount to their peers in the Utility sector on a price-to-earnings basis. But also at a discount to the broader market, the S&P 500.
 
Price/Earnings for Utilities
Forward 2017, Weighted Median
Heartland Advisors Value Investing Price/Earnings for Utilities Chart
Source: FactSet Research Systems Inc., Standard & Poor's, and Heartland Advisors, Inc., as of 11/15/2017
Shown as a percent of equity investments. Index sector weightings do not include unassigned holdings.
 
We think that's notable because we think that suggests that we had that valuation safety net in place. 
 
A great example of this would be one of our holdings, which is called Entergy Corporation. 
 
Entergy's growth catalyst is where it's located. They’re located in the Gulf Coast.
 
As you’re probably familiar with, there’s a significant amount of investment going into petrochemical-related facilities, or other industrial sites, that are tapping into lower feedstock costs—principally natural gas. 
 
We think that trend continues for some time, and that should be a tailwind for Entergy.
 
Entergy is contrarian. Not a lot of analyst rate it a buy. 
 
They don't have it a buy because—while they have a regulated business, which is the lion’s share of the cash flow, the lion’s share of their business—they have an unpopular, unregulated business, or a merchant businesses that’s more volatile in nature.
 
Traditional Utility investors don't like volatile businesses.
 
But if you look at the business strategy for Entergy, they have outlined a game plan over the next several years where they’re going to wind down this business. 
 
So, while we’ve highlighted a Utility example today, we’re going to continue to monitor the broader investment landscape across all sectors, across all market caps—to unearth those ideas that perhaps are out-of-favor, misunderstood—and find those that meet our parameters, our 10 Principles of Value Investing™. Because we think that could set the stage for gains for shareholders.

 

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