Heartland Mid Cap Value Fund 1Q20 Portfolio Manager Commentary

Executive Summary

  • Stock selection was strong on a relative basis and the portfolio outperformed its Russell Midcap® Value benchmark.
  • The current environment has created a well-stocked pool of opportunities.
  • As we sort through the companies that hit our radar, we will not change our philosophy or process. 

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.

First Quarter Market Discussion

The major indices sold off as investors struggled to quantify the impact of an unforeseen global health challenge. The uncertainty led to record volatility, as shown below, and indiscriminate selling prevailed. The rapid erosion of the markets was in stark contrast to the generally upbeat mood on Wall Street to start the year.

CBOE Volatility Index
Heartland Advisors High Beta/Low Volatility

Source: FactSet Research Systems Inc., 1/2/2004 to 3/31/2020
Chicago Board Options Exchange Market Volatility Index (CBOE VIX) is a mathematical measure of how much the market thinks the S&P 500 Index option will fluctuate over the next 12 months, based upon an analysis of the difference between current S&P 500 put and call option prices. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.


While fears related to coronavirus drove the selling pressure, other factors added to the decline. A carryover of investor euphoria from the strong showing in 2019 left valuations rich even against robust growth expectations. As the number of COVID-19 cases spiked, what had been considered reasonable economic projections quickly were viewed as overly bullish.  

Oil prices tumbled in reaction to the prospect for lower demand in the months ahead as well as a price war that broke out after OPEC failed to reach an agreement on production cuts. Weakness in the Energy space had a carryover effect on other cyclically oriented businesses.

Finally, economic pessimism caused lenders to tighten their lending activity to certain pockets of the economy, and investors grew wary of highly levered businesses. 

Attribution Analysis
The portfolio’s holdings held up on a relative basis and the strategy outpaced its Russell Midcap® Value benchmark for the quarter. Consumer Staples stood out on a relative basis, along with the portfolio’s Real Estate names. Holdings in Information Technology (IT) and Materials lagged. 
 
Heartland Advisors Value Investing Health Care Sector IconA live wire. IT holdings hurt performance, with much of the weakness coming from a single name in the software industry. While the technology sector continued to face uncertainty tied to COVID-19, we believe valuations in the space offer meaningful upside to investors with a long-term perspective. For example, we remain constructive on longtime holding Western Union Company (WU).

As the largest money transfer provider in the world, Western Union has an unmatched network of third-party agents as well as a robust business solutions segment which offers payment and foreign exchange solutions to small and medium sized companies. 

During the past 12 months, management has committed to improving margins and has opened up the company’s network to white label/co-branded opportunities such as Amazon PayCode. The moves caught the attention of investors and Western Union shares surged in the second half of 2019. At the time, we harvested gains but continue to see opportunity as valuations have become more attractive due to the stock selling off.

We believe the white label partnerships Western Union has entered will enhance its position as the industry leader and will provide further opportunity for growth. Additionally, the company’s efforts to boost its digital presence could lead to mid-teen growth in its consumer segment. 
 
Gassed. Global economic concerns along with OPEC’s failure to reach an agreement on oil production drove a significant pullback in the Energy sector. The portfolio’s names in the space sold off but fared better than the average for the benchmark. In light of the weak pricing power for producers, we’ve sought to own companies with strong balance sheets and top-tier assets such as Pioneer Natural Resources Company (PXD). 

Pioneer is the largest independent producer operating in the Permian Basin. The company’s size, along with its resource-rich drillable acreage, low-cost structure, and financial strength provides the business with a competitive advantage and the ability to withstand temporary shocks to demand and pricing.

Management has implemented a massive streamlining initiative at Pioneer that has already begun to boost free cash flow generation and has resulted in dividend increases and share buybacks. The company has also been selling non-core assets, which provides it more flexibility in the future and has further bolstered its financial position.
 

Portfolio Activity

While we continue to monitor macro events that will impact the global economy, our focus remains on finding and owning companies that are poised to succeed against a variety of backdrops or those that are priced at significant discounts to mid-cycle earnings levels. Our approach requires patience but can lead to investments in market-leading businesses. For example, we recently took a stake in Advance Auto Parts, Inc. (AAP).

AAP is a dominant player in the fragmented auto parts industry. The company differentiates itself from peers through its client mix. While competitors focus on the do-it-yourself consumer, AAP has a significant advantage—more than double its closest peers—marketing to repair facilities. Unlike retail customers, who are generally price sensitive, commercial customers prioritize delivery speed and parts availability over cost savings. We believe this should help insulate the company from pricing pressures and volume erosion spurred by online retailers. 

We took a stake in the business after it experienced what we view as a temporary pause in its self-help efforts. Despite the setback, we’ve been impressed with management’s ability to grow sales, and the significant strides made toward its goal of reducing $1 billion in inventory and increased operating margins. We view the lull in progress as temporary and believe business leaders will continue to increase profitability in the quarters ahead.
 

Outlook and Positioning

As bottom-up investors, we believe our job is to seek attractively valued companies that are well positioned to improve results and gain traction with investors. As such, we avoid making market calls and instead focus on capitalizing on the opportunities presented. The current environment, while painful, has created a pool of opportunity that is well-stocked with high-quality companies trading at compelling multiples. 

As we sort through the companies that hit our radar, we will not change our philosophy or process. The team continues to focus on valuations, balance sheet strength and catalysts that can result in a change in perception by investors. We believe this disciplined application of our process will be key to navigating the quarters ahead. 

Thank you for the opportunity to manage your capital.

 

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He has 17 years of industry experience, 10 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value, Mid Cap Value, and Value Funds and their corresponding separately managed account strategies. He also is President and Director of Heartland Funds. He has 19 years of industry experience, 16 at Heartland.

Fund Returns

3/31/2020

Scroll over to view complete data

Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
Mid Cap Value
Investor Class
0.53----0.32-6.15-24.32-31.62-31.62
Mid Cap Value
Institutional Class
0.77----0.07-5.93-24.21-31.62-31.62
Russell Midcap® Value0.20----0.76-5.97-24.13-31.71-31.71
*Not annualized

The inception date for the Mid Cap Value Fund is 10/31/2014 for the investor and institutional class.

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In the prospectus (pdf) dated 5/1/2020, the Net Fund Operating Expenses for the investor and institutional classes of the Mid Cap Value Fund are 1.10% and 0.85%, 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 1.10% of the Fund’s average net assets for the investor class shares and 0.85% for the institutional class shares, through at least 5/1/2022, 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 1.36% for the investor class shares and 1.07% 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 3/31/2020, Advance Auto Parts, Inc., Pioneer Natural Resources Company, and Western Union Company represented 1.90%, 2.08%, and 1.19% of the Mid Cap Value Fund’s net assets, respectively. Portfolio holdings are subject to change. Current and future holdings are subject to risk.

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.

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.

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®.

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

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

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.

Heartland’s investing glossary provides definitions for several terms used on this page.

The above individuals are registered representatives of ALPS Distributors, Inc.

The Heartland Funds are distributed by ALPS Distributors, Inc.

CFA® is a registered trademark owned by the CFA Institute.

The Mid Cap Value Fund invests in a smaller number of stocks (generally 30 to 60) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns. The Fund also invests in mid–sized companies on a value basis. Mid-sized securities generally are more volatile and less liquid than those of larger companies. There can be no assurance that the Fund will grow to or maintain an economically viable size, in which case the Board of Directors may determine to liquidate the Fund.

There is no assurance that dividend-paying stocks will mitigate volatility.

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

The Mid Cap Value Fund seeks long–term capital appreciation and modest current income.

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