3Q26 Value Fund Commentary Podcast

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

Will, this year, small value has been doing really well, but it was a volatile quarter. So how would you describe the universe here in Q3?

Will Nasgovitz: It was definitely a period where small value underperformed.

I mean, large cap S&P 500 was up over 2% in the third quarter. The Russell 2000® Value was down nearly 5%. If I had to guess, you know, the driver of  that is just rates, you saw a big move in the 10-year treasury, for instance, It's from four and change to nearly five and change, somewhere around that level.

So, concerns about what that might mean for small caps with higher rates that trickles into the economy. Small caps are typically more levered. That could impact their profit and loss statements and maybe top line down the road. So I think that's probably the driver of it. But you know the opportunity is still set, remains pretty robust when I think about the asset class.

Michael: Yeah, you know, that was going to be my next question. When these times come and these macro factors are kind of pushing the market around, particularly our asset class, how does it make you think about the portfolio? 

Will: We continue to just utilize our 10 Principles of Value Investing™ and being aware of where we are situated from a portfolio construction standpoint and acting on, you know,what the market's giving us. 

We lagged, you know, pretty substantially in the quarter. We're down nearly 7%. So underperformed our benchmark by a decent margin was unfortunate. And we're, but, you know, I look back at the kickoff, the quarter, and we like to look at, you know, our stocks relative to the price targets, to the upside, to the downside. And when it's not skewing well, I mean, the risk reward isn't attractive. We're going to act on it. So taking what the market gives us. And I was looking at some of our holdings, you know, kickoff Q3 and those that were not attractive from an upside versus downside, then we took some chips off the table.

So we're, you know, we've been doing that over the last several years now. So, you know, I think we're just going to continue to stick with our process. It didn't work in the most recent quarter, but I still think the opportunities set in what we own today should be attractive for longer term outperformance.

Michael: And we've been beating, and to your point, three, five, ten-year basis, we've been outpacing the benchmark. So maybe just a reminder of those core tenants that you're utilizing that are driving the longer-term results. 

Will: Yeah, focus on the 10 Principles of Value Investing™, great tool for identifying attractive opportunities to buy and then sell as the score deteriorates, when we're ranking them across the 10. Then just trying to be mindful of where we are from a sector and industry standpoint versus our peer group, but then also enhancing that awareness from you know, factor analysis,  to see where we're exposed from things like beta, or volatility, or profitability, or dividend yield, small versus large, earnings yield, etc. It’s just we don't want any of those factors, sector industry, or factors to drown out the 10 Principles.

So, in the quarter we did not have good security selections you know three areas really stand out, Energy was our worst Industrials was our second worst followed by Information Technology. On the Energy side it was, it was in services, energy services, you know some headwinds associated with the conflict of the Middle East for instance have weighed on some of our service names where volumes out of the Middle East have been challenged.

We think there's a light at the end of the tunnel there, particularly out of the Hormuz, but that's, you know, we will see how that all shakes out, but a lot of pain there. We think that's really reflected some, some draconian outlook there going forward. So we're actually excited about that side of our energy services holding to the back half of this year.

Industrials, you know, we had some E&C names that were weak in the quarter, same on the staffing side. The E&C names we were trimming over the course of the year, back to that risk-reward. Like, you know, looking back, maybe we should have trimmed some more because they hurt in the quarter. But we still like the longer-term fundamentals. And now the stock's set back. It's probably more of a buy than a sell today, certainly. Some other staffing names hurt us, too. And that's been a function of just kind of the AI concerns in the marketplace. And again, we think some of those things are probably misguided or too onerous in terms of the outlook. So again, we had taken some chips off the table there and earlier in the year and are sitting with that position because we like the long-term minerals. 

On Tech, again, in one of these names or groups that have been caught up in the AI crosshairs, I guess, software in particular, where we actually think there's some really interesting opportunities. We're more underweight that group, given the carnage that we've seen there. We're identifying a really attractive watch list and some new positions over the course of this quarter and here and starting the fourth that we think will be quite compelling for our shareholders longer term because we just think that that bear case is probably too extreme. 

Michael: Great. Now, I know every Monday morning, you're getting together with the team to kind of kick the week off. And the Small Cap team all brings their thoughts together across our Strategies. What's taking up those conversations these days?

Will: Well, we're thinking about, you know, 2020 or 2027, right? What's the opportunity set there? Where do we, you know, skating to where the puck's going to be? And we've got the watch list. We've always utilized that process when we have a need in the portfolio, perhaps we have a holding that's acquired. For instance, we had some acquisitions over the course of this year.

Those proceeds have to be put somewhere. We don't, you know, keep it in cash, for instance. So that watch list really comes in handy. So identifying those needs in the portfolio, given some of the transactions that we've had because we've had buyouts, because we've had names that haven't worked, maybe some of our funnel work was wrong. You know, identifying those mistakes, learning from them, and then finding ideas that we think are really compelling from a risk-reward standpoint, but also certainly, you know, fit our 10 Principles. So, that's the conversation, not just, you know, today, but all the time.

Michael: Yeah

Will: You know, how can we find the best opportunity to make the right decision for our clients.

Michael: And you're not sitting in the meeting talking about where everybody thinks rates are headed. 

Will: No, we certainly pay attention to it, right? 

Michael: Sure

Will: And then, you know, think about sensitivity, you know, to a name level basis. But no, we don't have a top-down deal, but we have to be aware of that. 

Michael: Sure. 

Will: Interest rates, the economy, commodities, etc. There's lots of ways to inform our thinking on that. But again, we want to focus on the micro side, the fundamentals of a particular company and how it can navigate perhaps higher rates.

Michael: Is there a name just reflecting on the quarter that you might want to give a little bit more detail around?

Will: We talked about three in our write-up. Interger Holdings (ITGR) was acquired, so we're excited about that. It's in the Health Care space. So there's a need there, right, as we think about using those proceeds in 2027 to be more balanced in that particular Health Care space. I think that's going to be an opportunity for us. There's a lot of opportunities in Health Care. Health Care's been caught up in terms of some underperformance valuations that are very compressed. So I'm excited about the opportunity set there. 

We talked about Academy Sports and Outdoors (ASO). It's in the Retail side. It has a really strong quarter, really attractive multiple of earnings here. Same-store sales are getting a little bit better there, so we think that's an intriguing idea here as well.

And then last but not least, we talked about Hillman Solutions (HLMN). This is a high-quality Industrial that next time you're at the hardware store, you go to the nut section, the nail section, that's Hillman. And we think it's just an asset-light, attractive business that has a mode around the business and trading a really attractive multiple. So, not just one, you know, three names that I think are really going to create value for our shareholders' longer term.

Michael: Excellent. And I know sometimes heading into this time of year, particularly in small cap land, there can be some stocks that get caught up in tax loss selling and maybe create opportunity. Any thoughts on that?

Will: Yeah, it's going to be, it's extreme or more extreme or it feels like it is. I don't have any, I guess, empirical on that. But when the market's up, you know, names that are underperforming typically face extreme tax loss selling pressure. That will probably continue here and the start of the fourth quarter and close out during the year as people work through their SMAs as well.

So it will present some opportunities. We're seeing it in a number of our watchlist names that have breached the downside targets and are, you know, getting close to those max downside losses. We don't own those, but we're looking at them. It looks like the risk reward is quite compelling. So it can create opportunities, but it probably continues as we, you know, get into the fourth quarter. 

Michael: Be patient

Will: Look for things like insider buying, make sure you're not forcing anything. Don't want to double down on something you already have exposure to in the portfolio and try to have that balanced approach. 

Michael: Excellent. Any other thoughts?

Will: No, I think that's a good recap. We're going to continue to, you know, we use our 10 Principles to find opportunities, stay in our lane in terms of our exposure so we're not too skewed. And really, there's the opportunity set is still quite compelling. I've referenced in the past where some of these industries that have been in these long downturns, they've been capitalized on these opportunities because the outlooks are looking better. I think some of the AI headwinds are maybe dissipated to some extent, where some people realize some of these software businesses or Utilities that don't have AI exposure are quite attractive. So it's created opportunities. AI is going to transform our economy, but it's really transforming the opportunities that too because so many businesses have sold off because of, you know, disintermediation risk, etc.

Michael: Excellent. Well, thank you so much, Will, for your time and your comments. 

Will: Thank you.