Heartland International Value Fund 2Q17 Portfolio Manager Commentary

Executive Summary

  • Security selection was positive on an absolute basis, but the Fund’s Materials holdings contributed to the portfolio lagging the Russell Global® ex-US Small Cap Index.
  • Holdings in Japan and Hong Kong were top contributors.
  • We’ve taken strength in several of the Fund’s holdings as an opportunity to harvest gains.
  • Portfolio valuations continue to appear compelling against the broader market.

Second Quarter Market Discussion

Continued signs of improvement in many developed economies provided a broad boost for international equities. China’s strong year-over-year economic growth was particularly encouraging. While Europe’s business expansion was more muted, there is a sense that countries in the region will work more closely together as leaders try to counter recent protectionist rhetoric on trade from the U.S. 
Strengthening local currencies in many regions also provided a tailwind to equities. Emerging Markets benefited as the effect helped commodity producing countries overcome softening oil prices. The United Kingdom was an exception to the trend as the pound weakened on heightened concerns in response to election results in June. The vote was a blow to the conservative party and results were viewed as hampering Prime Minister Theresa May’s hand in Brexit negotiations. 
We cannot control macro factors, but as bottom-up investors we can capitalize on opportunities that arise in response to external events. Valuations for international stocks remain significantly more attractive than U.S. stocks and we have been diligent in maintaining a portfolio that is dominated by dividend payers, diverse by region, and sector that, as shown, trades at a discount to the broader market.
True to Our Value Discipline
Weighted Median Valuation Analysis

Heartland International Value Fund Portfolio Manager Commentary Valuations Chart

As of 6/30/2017. *Weighted Average.
Source: FactSet Research Systems Inc., Russell® and Standard & Poor’s
All indexes are unmanaged. It is not possible to invest directly in an index. Portfolio holdings are subject to change. Current and future holdings are subject to risk. Past performance does not guarantee future results.

Attribution Analysis

Security selection was positive on an absolute basis, but weakness in the Fund’s Materials holdings contributed to the portfolio lagging the Russell Global® ex-US Small Cap Index. Information Technology (IT) also detracted while holdings in Real Estate were up sharply and outperformed the benchmark. 
On a regional basis, stock selection in Japan and Hong Kong was strong but was offset by weakness in Canada and UK holdings. 
Prized property. Stock selection in Real Estate was a key contributor, as our names in the space averaged double-digit gains. Far East Consortium International Limited (35HK), a billion dollar property development and management company, was a top performer after announcing a year-end 25% increase in revenue and 52% jump in earnings. 
The developer has a robust pipeline of projects nearing completion, plus increased occupancy at its Hong Kong properties should translate into significant revenue improvements during the next two years.
Even after recent strong performance, the stock remains a tremendous value, in our view, trading at 7.8x estimated 2018 earnings and just 90% of book value despite offering a more than 4% dividend yield. 
A casualty of claims. Our Financial holdings were up on an absolute basis but contained a key detractor. Novae Group PLC (NVA LN), a specialty insurer that is part of the Lloyds of London syndicate, was off after it was hit by several large claims during 2016. The coverage events were tied predominantly to the insurer’s business casualty line, which it is in the process of exiting.
Current pessimism about earnings challenges stemming from claims, we believe, is overdone and should lead to higher premiums in the quarters ahead. As Novae leaves unprofitable areas of coverage, it should free up cash previously set aside to pay claims and that money could be used for share repurchases.
With shares trading at 1.1x book value compared to an average of 1.8x peers, we believe investors are overlooking the competitive advantage Novae maintains by being a part of the Lloyd’s group of insurers, and we expect strengthening valuations going forward. 
Running like a top. Industrial names were up on an absolute basis and contained a top contributor. Deutz AG (DEZ GY), a manufacturer of diesel engines primarily for the European market with more than 35% of its sales tied to construction equipment, was a top performer. The company reported results that beat consensus expectations. Sales of new engine models that meet tougher European emission standards are contributing to positive operating leverage and bottom-line growth.
We are also encouraged by early signs of a recovery in the agricultural industry, which could boost sales in the coming quarters. Shares of the company have enjoyed a strong run during the past few quarters, and we have trimmed the number of shares held to manage the Fund’s exposure.

Portfolio Activity

We’ve taken strength in several holdings as an opportunity to harvest gains and redeploy assets in other attractive businesses. Our allocation to Financials is down, as we’ve trimmed our commitment to capital markets and financial services. We’ve reduced exposure in Industrials and added to some Consumer Staples holdings. The Fund remains underweight in Japan but, at 20% of assets, we remain committed to the region. In recent travels, we’ve uncovered opportunities in the country that could result in purchases in the months to come.   

Outlook and Positioning

We expect recent calm in the global markets will give way to increased volatility in the months to come. Japan remains attractive from a long-term perspective, but strength in economically sensitive areas has made bargain hunting more challenging.

Fallout from the Brexit vote will begin to take shape as leaders in the UK negotiate the ending of the country’s membership in the European Union. The UK continues to be an area of interest due to attractive valuations and more modest expectations compared to U.S. markets.

Heartland International Value Fund Portfolio Manager Commentary Quote

China’s improving economy and its efforts to reduce risk in its financial sector should have long-term, positive effects for investors. However, near-term the moves could spark some temporary volatility.

We are also seeing opportunities in Emerging Markets. However, valuations have moved higher along with stock prices. Continued weakness for many commodities will put pressure on some Emerging economies and commodity producers.

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 may mitigate downside pressure 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 14 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 34 years of industry experience, 4 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.

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As of 6/30/2017, Deutz AG, Far East Consortium International Limited, and Novae Group PLC, represented 1.07%, 2.43%, and 2.97% of the International Value Fund’s net assets, respectively. 

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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.

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