Heartland International Value Fund 1Q18 Portfolio Manager Commentary

Executive Summary

  • International markets avoided much of the volatility endured by U.S. equities during the quarter.
  • Valuations remain compelling and provide significant opportunities for fundamental investors.
  • We have used temporary macro concerns as an opportunity to invest in sound companies that are trading at discounts to peers.
  • More than 92% of your Fund is in dividend-paying stocks, which we believe provides downside protection while allowing for upside potential.

First Quarter Market Discussion

International markets avoided much of the volatility endured by U.S. equities during the quarter. Instead, investors balanced positive economic data, faster gross domestic product (GDP) growth in many economies and attractive valuations against the reality that central banks are becoming less accommodative.
While talk of tariffs and trade wars sparked selling pressure toward the end of the quarter in the domestic markets, investors abroad shrugged off the discussion and the major international indices finished the period down slightly.
Cause for Continued Optimism?
International small-cap stocks have outperformed a number of domestic indices during the last two years and we feel it is early in this process. As the chart below shows, International stocks are trading at historic lows based on price/book relative to their domestic peers. These wide valuation spreads between the two categories could indicate that it is early in this developing sea change between domestic and international equity returns. Should past cycles represent a guide, the narrowing of these spreads may imply that international returns could outperform and close the return gap against domestic stocks. Internationally value abounds and to capitalize on this opportunity we remain focused on value and prices paid.
A Value Advantage?
International Stocks Relative to U.S. (Price/Book)
Heartland Advisors Value Investing Price to Book Chart
Source: Copyright © 2018 The Leuthold Group, Morgan Stanley Capital International (MSCI), Standard & Poor’s, and Heartland Advisors, Inc., 12/29/1995 to 3/30/2018
Price/Book Ratio is calculated using MSCI EAFE Index (international stocks) divided by S&P 500 Index (U.S. stocks).
Past performance does not guarantee future results.

Attribution Analysis

The portfolio’s Information Technology (IT) holdings were up sharply and Health Care and Utilities helped boost the Fund on an absolute basis. Weakness among Consumer Discretionary and Materials holdings, however, caused the portfolio to lag its benchmark, the Russell Global® ex-US Small Cap Index.
Allocation decisions were positive and contributed to overall performance. 
Heartland Advisors Value Investing Information Technology Sector IconValue recognized. The portfolio’s IT names were up sharply and the group contained a top contributor. Laird PLC (LRD LN), a United Kingdom-based technology company whose products are used in multiple industries including automotive, health care and telecommunications was up 50% during the period after a private equity firm announced it was acquiring the company. We took a stake in the company in late 2016 and had been closely following the new management’s progress in restructuring and fortifying the balance sheet. 
Laird had recently reported strong earnings and revenue growth. The company’s attractive valuation and effective management caught the eyes of investors and the announced bid represented a 73% premium over the previous close. The offer represented a premium over our estimates of intrinsic value and we sold the Fund’s position. 
Heartland Advisors Value Investing Industrials Sector IconThe right fit. Sung Kwang Bend Co., Ltd. (014620 KS), a South Korea-based manufacturer of large industrial fittings used by petrochemical factories, ship builders, and nuclear power plants was a top Fund holding in the Industrial space. The stock was up as the company reported a jump in orders with more growth expected in 2018. 
The company is one of a handful of players certified as meeting exacting standards to create products for fittings and valves in the highly specialized industry. The rigorous standards required to become an approved manufacturer makes it difficult for new entrants to the space. With Sung Kwang Bend trading at just 70% of book value versus an average of 120%, we believe the market has yet to fully appreciate the potential for topline growth with the cycle now turning up.
Heartland Advisors Value Investing Consumer Discretionary Sector IconIn good taste. The Fund’s Consumer Discretionary names were off, but the group contained a top performer. DO & CO Aktiengesellschaft (DOC AV), a catering and food services company was up as management continues to win new contracts and execute on plans for expansion. The business operates a premium catering services for overseas airlines, as well as company owned restaurants and a foodservice unit for international sporting events such as Formula One racing.  
Management has expanded the company’s global footprint and leveraged existing infrastructure to boost sales while preserving DO & CO’s industry-leading margins. The company recently won business from Qatar Airways and has a pipeline of four other major contracts out for bid. While investors have begun to take notice, we believe significant upside remains. Shares currently trade at 7.1x estimated 2019 enterprise value/earnings before taxes, interest, depreciation and amortization, well below the peer average of 11.5x.

Portfolio Activity

We’ve taken strength in several holdings as an opportunity to harvest gains and redeploy assets in other attractively valued businesses. Our investment process remains focused on valuations, and we have used temporary macro concerns as an opportunity to invest in sound companies that are trading at what we believe are temporary discounts. 
All under one roof. Ongoing concerns about a softening housing market and the fallout caused by Brexit has allowed us to take a stake in LSL Property Services Plc (LSL LN), a UK-based market leader in residential real estate services. The company is involved in sales, financing, renting and valuing properties throughout England. Additionally, the company has a significant portfolio of residential units it manages for corporate investors. 
LSL’s expertise and diverse lines of business provide it with multiple revenue streams to sustain it through the current real estate downturn. We believe this ability to generate cash flow puts management in a strong position to make opportunistic acquisitions and gain market share. 
Despite its strong portfolio of businesses, shares of LSL are trading at just 8.1x estimated 2019 earnings or less than half or the 17x multiple commanded by its global peers.

Outlook and Positioning

Heartland Advisors Value Investing Quote ImageWe view recent market turbulence as a temporary setback to what remains a sound economic backdrop. As 2018 continues to unfold, we remain constructive on global business prospects. However, as the expansion continues to churn on, new challenges will emerge. Global central banks have signaled a transition to a less accommodative posture, Brexit negotiations have been slow and painful, and trade wars may be on the horizon for many of the largest developed economies. 
The result of these and other unforeseen challenges could lead to a market where valuations compress while earnings continue to grow. As such, we continue to believe today’s markets call for an active approach that is based on a consistent philosophy and executed using a disciplined process. 
Our focus remains on finding sound businesses with strong management teams that have a history of prudent capital allocation decisions. We believe owning dividend-paying companies with robust balance sheets provides downside protection while allowing for upside potential.
Thank you for the opportunity to manage your capital.
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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Michael Jolin

Michael Jolin

Jolin, CFA, is Vice President and Portfolio Manager for the Heartland International Value Fund. He has 15 years of industry experience, 8 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Robert Sharpe

Robert C. Sharpe

Sharpe is Vice President and Portfolio Manager of the International Value Fund. He has 35 years of industry experience, 5 at Heartland.

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In the prospectus (pdf) dated 5/1/2018, the Net Fund Operating Expenses for the investor and institutional classes of the International Value Fund are 1.25% and 0.99%, respectively. The Advisor has contractually agreed to waive its management fees and/or reimburse expenses of the Fund to ensure that Net Fund Operating Expenses for the Fund do not exceed 1.25% of the Fund’s average net assets for the investor class shares and 0.99% for the institutional class shares, through at least 5/1/2019, and subject thereafter to annual reapproval of the agreement by the Board of Directors. Without such waiver and/or reimbursements, the Gross Fund Operating Expenses would be 1.84% for the investor class shares and 1.45% for the institutional class shares.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual's return.

An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

As of 3/31/2018, DO & CO Aktiengesellschaft, LSL Property Services Plc, Laird PLC, and Sung Kwang Bend Co., Ltd. represented 3.09%, 0.80%, 0.00%, and 2.60% of the International Value Fund’s net assets, respectively.

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.

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Sector and Industry classifications are sourced from GICS®.The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global Market Intelligence (“S&P”).  Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose.  The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

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The International Value Fund invests primarily in small foreign companies selected on a value basis. Such securities generally are more volatile and less liquid than those of larger companies. Foreign securities have additional risk, including but not limited to exchange rate changes, political and economic upheaval, and relatively low market liquidity. These risks are magnified in emerging markets.

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