Heartland International Value Fund 3Q17 Portfolio Manager Commentary

Executive Summary

  • The Fund posted positive absolute returns, and was up 14.47% through the first three-quarters of the year.
  • The optimism that is propelling international markets higher appears to be grounded in reality.
  • Valuations in today’s markets call for an active approach that is based on a consistent philosophy and executed using a disciplined process.

Third Quarter Market Discussion

Economic optimism and a continued accommodative stance from central banks around the globe boosted international equities. Strengthening of several major currencies also provided a tailwind to global markets.
The upbeat outlook was reflected in the subdued reaction to geopolitical events. Unlike in the U.S., where macro concerns created a sense of uncertainty and resulted in a more defensive stance for the markets, international investors shrugged off headlines such as challenging Brexit negotiations and German election results that showed a renewed embrace of populism. 
Despite the strong run for international stocks, valuations remain compelling, and, as shown, provide significant opportunities for fundamental investors. We are steadfast in our belief that discovering investment opportunities requires tireless research focused on multiples and prices paid.
Time for the Gap to Narrow? 

Heartland International Value Fund Portfolio Manager Commentary R3 versus RGxUS Chart

Source: Bloomberg L.P., Russell®, and Heartland Advisors, Inc., 12/31/1996 to 9/30/2017 
All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.

Attribution Analysis
The portfolio saw double-digit gains in a number of sectors and was up on an absolute basis. Weakness among Consumer Discretionary holdings, however, contributed to the portfolio lagging the Russell Global® ex-US Small Cap Index.

Consumer Staples names led the way higher followed by Financials holdings. On a regional basis, stock selection in the United Kingdom and Japan was strong. 
Heartland Advisors Consumer Staples Sector IconWinning a spirited battle. Stock Spirits Group PLC (STCK LN), a leading branded spirits player in Eastern and Central Europe, was a top contributor. We took a stake in the Consumer Staples company two years ago when it was in the midst of fending off a pricing war with a financially weak competitor. At the time, we believed the competing firm’s price cutting was unsustainable and Stock Spirits brand strategy would prevail. 
Since then, Stock Spirits has been diligent in maintaining its cost and pricing discipline and recently reported the efforts are paying off as market share has improved and margins remain intact. We believe pricing in the market will remain strong and are impressed with the company’s CEO who continues to build brand strength through strategic bolt on acquisitions.  
Even after recent strong performance, the stock remains a compelling value, in our view, trading at just half of its peer group average based on current enterprise value/earnings before interest, taxes, depreciation and amortization. 
Heartland Advisors Financials Sectors IconFinancial opportunities. The Fund’s Financials holdings soundly outpaced those in the benchmark and we continue to find attractive opportunities in the space. For example, we recently initiated a position in ING Life Insurance Korea Ltd. (079440 KS), a Korean life insurance and financial services provider. The 30-year old company went public in spring but the offering was widely overlooked by investors. Historically, the company has been managed in accordance with more stringent European financial standards which has resulted in exceptional financial strength compared to other Korean insurers. Changes to capital requirements scheduled to take effect in 2019 should provide a competitive advantage to ING as peers are forced to shore up cash reserves. 
As the new requirements take effect, we expect ING will quantify the level of its excess capital, which may be used to reward shareholders beyond its already generous policy of paying out 50% of its net income. As its dividend rate increases, so too should investor interest in the company. 
With shares trading at 11x estimated 2017 earnings and a dividend yield of almost 5%, we believe investors are behind the curve in fully appreciating this newly public company. Eventually, as the new financial requirements take effect, investors should begin to clearly see the strengths of ING and shares, in our view, should trade at a premium to the industry. 
Heartland Advisors Consumer Discretionary Sector IconOff color. The Fund’s Consumer Discretionary names lagged and the group contained a key detractor. Technicolor SA (B4MMD8) was down after it reported earnings below analyst expectations due to higher costs for memory chips used in some of its products. Management also lowered its full-year guidance. We viewed the setback for shares as temporary and added to the fund’s position. 
The global media services company is comprised of three business lines: Content production, broadband distribution equipment, and Intellectual property. The distribution equipment and intellectual property units provide cash to grow the content production services group. We view the approach as a prudent way to invest in a high-margin division boasting 8%—10% annual growth.
As companies Apple Inc. (AAPL), Netflix, Inc. (NFLX), and Amazon.com Inc. (AMZN) continue to scramble to provide content in an increasingly competitive environment, we believe Technicolor will be well positioned to generate above market growth in the years to come. Despite a promising outlook, shares trade at less than 5x enterprise value/earnings before interest, taxes, depreciation and amortization.

Portfolio Activity

We’ve taken strength in several holdings as an opportunity to harvest gains and redeploy assets elsewhere. The Fund’s Energy exposure is up as pessimism has taken a toll on share prices regardless of the underlying strength of the company. In particular, we favor low cost producers with strong balance sheets that should participate as the price of crude increases but may hold up better if oil weakens. Additionally, the Fund’s holdings in the equipment and services industry should further mitigate the effects of changes in oil prices.  

Outlook and Positioning

The optimism that is propelling international markets higher appears to be grounded in reality—Japan is showing signs of improvement as are developed economies in Europe. China’s improving economy and its efforts to reduce risk in its financial sector should have long-term, positive effects for investors.

Heartland International Value Fund Portfolio Manager Commentary QuoteHowever, the strong run enjoyed by global markets has also stretched valuations. Opportunities still exist, but the ripe, low-hanging fruit has already been picked.  As such, 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 mitigates risk while allowing for upside potential.
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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 34 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 9/30/2017,Amazon.com Inc., Apple Inc., ING Life Insurance Korea Ltd., Netflix, Inc., Stock Spirits Group PLC, and Technicolor SA represented 0.00%, 0.00%, 2.50%, 0.00%, 2.85%, and 2.32% 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.

Economic predictions are based on estimates and are subject to change.

There is no guarantee that a particular investment strategy will be successful.

Sector and industry classifications as determined by Heartland Advisors may reference data from sources such as FactSet Research Systems Inc.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

The Heartland Funds are distributed by ALPS Distributors, Inc.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

Dividend paying stocks cannot eliminate the risk of investment losses.

Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

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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.