2Q26 Value Fund Commentary Podcast

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Michael Kops: Hello, I'm Michael Kops from Heartland Advisors. Today, I'm joined by Will Nasgovitz, Portfolio Manager for the Value Fund.

Will, how would you describe the small cap value market in Q2?

Will Nasgovitz: It was a strong market for sure. The Russell 2000® Value Index was up over 17%, which is you know an absolute big number for any quarter, for any year, really. So it's quite compelling, quite solid. The relative performance was good too. If you just look at a basket of large cap securities that Russell 1000® was up over 15%. So there was over 200 basis points of outperformance for small value relative to the large cap. So that's really encouraging.

Michael: Yeah, I think it's interesting, you know, small, value investors, oftentimes you see these big blowout returns, and I think it can send like a little error of anxiety permeating through, you know, just the thinking. Where almost like pre-wired for what evil lurks around the corner.

What challenges does this bring you when the market's bubbling like this?

Will: I think you just have to follow your process and your philosophy. And for us, it's this idea of being actively aware, both at the security level and at the portfolio level. And when I look at the portfolio, sure, the on average, the risk-reward across our securities is not as compelling as it was on April 1st of this year. But it's still positive. So I think it's just finding that, you know, taking advantage of what the market's giving us in terms of there's been strong performance and, you know, Technology would probably stand out, right, with the AI-related investment that's going on. So we've been taking some gains there because the market's presented some really compelling performance there that the risk-reward isn't as attractive as it was, and then funneling to something else that looks more attractive for us. 

So I don't know that it's a unique challenge. It's just the, you know, the day-to-day of portfolio management and trying to, you know, produce consistent investment results through our 10 Principles of Value Investing™. 

Michael: Great. So, it's not uncommon for value investors to suggest that when the markets boil like this, it's hard to hang on. 

Will: Mhm

Michael: Yet, you did a really good job. 

Will: Yeah

Michael: I mean, we're basically, I think we take benchmark returns in a 17% up quarter. 

Will: Right. 

Michael: How did you hang on?

Will: Well, we'd love to outperform. Yeah, we did trail our benchmark by, you know, 20 so basis points or something like that. So I always like to look, what can you learn from it? Right. And if you look at the quarter from an attribution standpoint, we underperformed on a security selection basis in 6 of the 11. So that hit rate's not what we want it to be. Encouragingly, maybe there's a silver line here, maybe I'm trying to fit my narrative, but the underperformance, like the scope and the severity across the groups where we underperformed wasn't anything that I think was alarming.

But look, you got to look at the performance in Tech. We didn't keep up. I'm really encouraged though how well we did that I give Mike Warecki, one of our teammates, a lot of credit for that he's unearthed a lot of opportunities for us the last several years that are now paying off. And we didn't reach there we had a really strong catalyst that have come to fruition you know. Principally on some of the AI related investments that again we weren’t chasing that. We found some opportunities that we might have success and we did. And then Health Care we lagged too that was more of a drag than Tech and I look I could as a value investor you could point, well, biotech was up over 20% in the quarter, at least biotech stocks in our, in our benchmark. And well, we, you know, that's not an area where we can, you know, it doesn't fit our process. 

Look, we're looking. It's a, it's a, it's a larger sub-industry in our benchmark. We want to be benchmark aware. We don't want to hug the benchmark. We want to win with our 10 Principles and we haven't found anything. So, we'll continue to look for opportunities there. And there's, I think we missed some opportunities in some other Health Care areas that, that would have helped our performance. Unfortunately, there was a lot of carnage or dislocation in Health Care and last year associated with NIH funding that went away with the Doge processes that were going on in Washington.

And we had a lot of things that we evaluated that we could have purchased and we didn't. And so I said, you know, what can we learn from that, right? I think we can find some higher quality businesses that go on sale because of something that's temporary. You know, we should capitalize on it. So, we kept up through good security selection in aggregate, but I think there's always some opportunities to learn. 

Michael: That's great. Maybe it's a good opportunity to talk about a name specifically in the portfolio that kind of shares how you're thinking.

Will: Yeah, I think it's a good question. I like to, let's focus on Tech because that was an area of underperformance and I think is really topical today. And if you look at one of the names that we talked about in the write-up was Photronics, ticker PLAB. And it's been a longer term holding for us. It's in the semi-cap equipment space. They make photomasks. And that's something that, you know, we get to this notion of being actively aware. We started the year, the risk-reward in the stock wasn't that compelling. You know, it's skew to its upside targets, whether it's intrinsic value or target price relative to its downside targets or max downside loss was not compelling. In fact, it was negative. So we took chips off the table. In fact, we cut our position by 50 percent of the first half of this year or to the first quarter or somewhere in that time frame.

And then the stock reported their results and the stock sold off significantly and the risk reward became compelling. So we've we added to it. I think that's just a good example of us following our process where the risk reward wasn't compelling. We took what the market gave us and subsequently the stock sold off on some investment that we're making or they're making, excuse me, here in their photomask production in North America that we think was really going to make them stand out. They'll be a leader in that. And the market, I think, is taking a really short-term view of that. We're capitalizing on that.

And similar on the software side, the software space has come under a lot of pressure with AI. And we have a holding, there are two holdings, but one that I call it that we added to is i3 Verticals, ticker IIIV. They're in the payment side. And the stock, like a lot of software businesses have been tarred by concerns about AI disremediating their business. We look at their profile, they're in the payment side, we look at their customer base, and we think what the market is perhaps suggesting is, you know, possible, but probably not in the timeframe that we think is, were likely.

And I think that's, you know, we can see that what gives us comfort in that too as the CEO bought stock during the quarter too. We added to that position. We think some of these concerns will be remediated over time. So we think the risk reward there is quite compelling.

Michael: Excellent. I'm curious in the case of, well, I guess it would be in all sorts of securities that where you've revisited a name we've owned in the past, but you just referenced Photronics.

How helpful is it, you kept your grids while we owned it the first time, and you got all your detail in the 10 Principles from all the grids from quarterly updates or one-offs that were worthy of an update to be able to pick up kind of where you left off when you exited, revisit the old grids, and restart the research from there?

Will: Well, in that case, we had never exited. 

Michael: Yeah, one you totally exited.

Will: Yeah, but no, but I think your point, though, having that institution knowledge is, I think, a real value add and something that, you know, helps us in our mission to produce consistent investment results. So it's extremely helpful, not only for the analysts that's following, but for the team. 

Michael: Yeah

Will: Bill and I, Jake and Mike, to talk about an idea and have some familiarity with it to varying degrees, right? Whoever's the primary is going to know it better. But it just helps build that case for, yeah, we should be adding to this when it's selling off, you know, double digits on an investment that's going to add value for the longer term.

Michael: It’s interesting the like when you were divesting the grid's getting worse. 

Will: Mhm

Michael: And then it continues to play out the grid starts getting better.

Will: Right 

Michael: And you just kind of watch that evolve. What about the outlook what are you thinking here through the rest of the year?

Will: I, it's a good question I think last quarter and maybe the prior quarter I talked about this idea of where we were coming off this really strong environment several years ago. And a lot of businesses are still working through now kind of the hangover, if you will. And it's encouraging to see, you know, we've been monitoring this in many industries. And I'll take like the machinery side, people that make heavy capital equipment. And I'm speaking to heavy capital equipment that doesn't go into AI, because that's really very topical right now, people making turbines, for an instance. Non-AI heavy capital equipment where we've now seen the business fundamentals trough and now it's maybe started to base out and now we think we're near an inflection point.

So I think that outlook is, you know, seeing that play out is really encouraging. We think there's a lot of opportunities in that. So we're excited about that and be able to exploit those opportunities where a lot of investors are not focused. So, overall, I think, you know, they all look to us kind of back to that earlier comment where the risk-reward across the portfolio is still solid, not as good as it was prior to this quarter's rally. But I think there's a lot of opportunities out there still. So, I'd say I still have a very positive outlook for the broader small-cap value universe.

Michael: Excellent. Thank you, Will, for the update.