Heartland International Value Fund 4Q17 Portfolio Manager Commentary

Executive Summary

  • The Fund posted positive absolute returns, up 19.04% for the year.
  • Valuations remain compelling and provide significant opportunities for fundamental investors.
  • Japan continues to gain traction as do developed economies in Europe.
  • Looking ahead to 2018, we remain constructive on the global economy, and believe new challenges will demand an active investment approach.

Fourth Quarter Market Discussion

International equities added to their year-long march higher as investors looked past geopolitical flare-ups during the period and instead focused on positive economic data, faster gross domestic product (GDP) growth and valuation characteristics. 
China entered the year as a question mark for many, but showed continued signs of improvement and provided a positive ripple effect for other global players. Although some of the major currencies softened, the effect was muted and limited to commodity-producing pockets in Emerging Markets. 
Valuations remain compelling for international stocks. Despite the strong run this year, international equities, as shown below, are still trading at less than half of domestic stocks as calculated based on a ratio of market cap to GDP. This measure is a favorite among value investors such as Warren Buffett because it provides an apples-to-apples comparison of valuations across different countries. We are steadfast in our belief that discovering investment opportunities requires a tireless focus on prices paid.
Time to go Global?
Heartland Advisors Value Investing Market Cap Relative GDP Chart
Source: Bloomberg L.P. and Heartland Advisors, as of 12/31/2016
Market Cap is calculated using Bloomberg’s World Exchange Market Capitalization in USD and Bloomberg’s United States Exchange Market Capitalization in USD. Gross Domestic Product (GDP) is calculated using World Bank World GDP in Current USD and GDP US Nominal Dollars (seasonally adjusted annual rate).


Attribution Analysis
The portfolio ended the year with double-digit gains. Strength in several sectors helped boost the Fund on an absolute basis during the most recent period. Weakness among Materials holdings, however, caused the portfolio to lag its benchmark, the Russell Global® ex-US Small Cap Index.

Information Technology (IT) drove returns higher along with the Fund’s Real Estate holdings. On a country basis, stock selection in South Korea and Japan was strong. 
Heartland Advisors Value Investing Portfolio Manager Commentary Information Technology Sector IconGetting animated. Wacom Company Ltd. (6727 JP), a Japan-based technology business we added in February 2017, was a top contributor. The company makes digital stylus products for consumers and high-end hardware and software for professional animation. 
We were drawn to the company based on valuations and its launch of several new products for its animation business. We believed the new offerings would drive replacement demand and lead to top line growth. Based on its most recent earnings release, those views were validated.
The company reported strong sales growth and forecasted an eye-popping 60% jump in operating income. New product cycles typically last up to four years, which we believe Wacom still has ample room for additional gains in sales and earnings. Despite the opportunity, shares are trading at just 1.2x sales, or toward the low end of the stock’s five-year average. 
Cashing in on Gen V. Strength in IT was widespread and the group contained an additional top contributor. Anritsu Corporation (6754 JP), a Japan-based manufacturer of test and measurement devices, surged on expected sales growth for its products related to Fifth Generation mobile telecom services (5G).
The company has a dominant market position in products and services related to 3G and 4G systems and we expect Anritsu to leverage its expertise as 5G gains traction in Japan prior to the 2020 Summer Olympics in Tokyo.
The strong showing for the stock has increased valuations, but at 2.1x book value shares are still near the average lows of the past 10 years. We have harvested gains in the second half of the year to manage our exposure. We will continue to monitor company results to ensure future sales are meeting our expectations.
Heartland Advisors Value Investing Portfolio Manager Commentary Industrials Sector IconA bad bounce. The Fund’s Industrial holdings boosted absolute returns but the group contained a key detractor. Semperit AG Holding (SEM AV) was down as it continues to unwind a joint venture and new management evaluates options to improve company performance. 
Semperit operates two business lines—industrial products, including hoses, conveyor belts and molded rubber products, and a medical division that supplies surgical and latex gloves throughout Europe. Management has invested heavily in building out the medical side of the business to expand its capacity and has been involved in joint ventures aimed at tapping new markets. 
Investment in the medical line will convert to greater sales, in our view, and, as the cost of new equipment is spread across more units produced, that margins should improve as well. Additionally, the review of business lines could result in cost cutting and higher margins for the company.
With the stock trading at just half the price/book multiple of its industry peers and with a 3% dividend yield, the market appears to be focusing too heavily on a near-term challenge and overlooking potential rewards in the years ahead.

Portfolio Activity

We’ve taken strength in several holdings as an opportunity to harvest gains and redeploy assets in other attractively valued businesses. The results of our work is a portfolio that is trading at a 33% discount to the benchmark on a price/book basis and 30% cheaper as measured by price/cash flow.
The Fund’s exposure in Materials is down, and we’ve increased our investment among Consumer Discretionary businesses. The Fund remains overweight in Industrials and we continue to find compelling opportunities in the space. 
Riding the rails. Vossloh AG (VOS GR) is an example of the type of high-quality business we’ve been able to uncover in the Industrials space. The German company is a major player in rail maintenance systems and produces fasteners and concrete ties used for train tracks. Additionally, it is the second-largest producer of customized rail modules in the world. Its products are used in applications ranging from light rail to high-speed passenger trains.
Shares have been under pressure as order backlog and sales projections for the coming year have softened. However, we believe the outlook for sales to China remains strong. The Chinese government has announced plans to expand the high-speed rail system by 50%, and more than doubling it to 45,000 kilometers over the next several years.
As high-speed rail continues to grow globally, we expect Vossloh’s high-margin maintenance business will bloom. Additionally, we expect its rail fastener and concrete rail ties should gain greater market penetration in North America in the coming years.

Outlook and Positioning

Heartland International Value Fund Portfolio Manager Commentary Quote
The international markets have enjoyed a Goldilocks year. Japan continues to show signs of improvement as do developed economies in Europe. The story in China has transformed from one of concern to that of a catalyst for global growth. A stabilized and improving energy market has also benefited developing economies. 
Looking ahead to 2018, we remain constructive on the global economy. However, as the expansion continues to churn on, new challenges will emerge. The European Central Bank could begin to unwind its policy of easy money. Germany has yet to form a government following its most recent elections, and Italians will be heading to the polls in March in an election that could once again test the strength of the European Union. 
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 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.

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As of 12/31/2017, Anritsu Corporation, Semperit AG Holding, Vossloh AG, and Wacom Company Ltd. represented 1.91%, 2.52%, 1.33%, and 3.03% 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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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®.

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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.