Heartland Advisors

Heartland Mid Cap Value Fund 1Q23 Portfolio Manager Commentary

Executive Summary

  • The banking crisis that emerged in the first quarter has a silver lining: Investors are finally focusing on fundamentals again.
  • This is a great environment for active value investors who care about a company’s balance sheet strength, reliance on the capital markets, and ability to self-fund growth. 
  • The near-term volatility offers investors an opportunity to buy companies with compelling risk/reward profiles over the next one to three years at a discount.

Past performance is no guarantee of future results and investment returns and principal value of the Fund will fluctuate so that shares, when redeemed, may be worth more or less than the original cost. Current performance may be higher or lower than the performance quoted. Call 800-432-7856 or visit heartlandadvisors.com for current month end performance.

First Quarter Market Discussion

The first quarter of 2023 will undoubtedly be remembered for the bank failures in March, brought about by the Federal Reserve’s rate hikes and poor asset-liability management. Fears of a full-blown crisis following the collapse of Silicon Valley Bank, Signature Bank, and Silvergate Capital dominated the market at the end of the quarter, putting an end to the speculative rally at the start of the year.

Yet the biggest story during the period was the reawakening of the market’s respect for risk, owing to the banking crisis. As credit spreads widen and lending standards tighten, the market’s focus is now shifting to other banks that may be vulnerable and other businesses that face either a liquidity crunch or could face a weaker demand environment.

This is a great environment for active value investors who care not only about valuations, but also about a company’s balance sheet strength, reliance on the capital markets, and its ability to self-fund operations and organic growth through free cash flow generation. At a time when balance sheet strength matters more, we note that our passive benchmark does not incorporate balance sheet considerations in their construction of the mid cap value universe. At Heartland, financial soundness and debt levels are directly applied to 3 of our 10 Principles of Value Investing™ and integral to the overall stock selection process.

This is also a time for investors to consider a balanced approach that plays both offense and defense. Part of our portfolio is comprised of companies that offer something the market isn’t seeing much of lately: stable fundamentals and improving earnings. On the other hand, we have used pockets of volatility to build positions in holdings that offer a compelling risk/reward proposition over 1 to 3 years, even if some of these companies face less certain business prospects in the near future.

Whatever happens, the banking crisis is likely to accelerate the current credit cycle. As the chart below illustrates, there are three stages to a credit cycle. First, the Federal Reserve begins tightening monetary policy in response to rising inflation and falling unemployment (red line). Next, lenders begin tightening credit standards (green line). And finally, loan losses rise and lenders write off bad credits (blue line). We believe we’re in stage 2 now, but it’s important to note that stage 2 and 3 generally peak after the Fed begins to cut policy rates.

Heartland Advisors Value Investing Credit Cycle

Source: FactSet Research Systems Inc., monthly data from 1/31/1992 to 3/31/2023. The chart illustrates the three stages of the credit cycle. Stage one is Federal Reserve tightening monetary policy in response to rising inflation and falling unemployment. Stage Two is lenders tightening credit standards and stage three is when loan losses rise, and leaders write off bad credit. The seasonal adjusted Charge-Off Rate is calculated using all United States commercial banks, commercial & industrial loans. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Attribution Analysis

In the first quarter, our portfolio outperformed the Russell Mid-Cap® Value Index. The outperformance was largely due to stock selection in the Industrial, Information Technology, and Financial sectors.

Heading into the quarter, we had shifted our purchase activity toward beaten-down shares of well-run businesses that we believed would benefit if the market became less fearful of the business cycle. However, after the “risk on” rally that started the year, which drove up prices throughout most cyclical areas of the market, mispricing opportunities were harder to find, and this became less of a priority. Yet another reason to implement a balanced approach.

Portfolio Activity

Among value investors, there are those who prefer owning high-quality companies trading at decent bargains (“value”) and others who focus on deeply discounted companies that have produced poor economic returns over time (“deep value”). Just as growth and value take turns outperforming, these two styles within value investing also tend to alternate market leadership. Within the mid-cap space, choosing one while ignoring the other does not seem prudent, as this can cause a top-down bet to be introduced into the portfolio. We aim to have stock selection drive our results, which we believe can only be achieved if the uncontrollable is somewhat mitigated. 

Deep Value Bucket

Health Care. During the quarter, we added to our existing position in Centene Corporation (CNC), one of the largest managed health care insurance providers in the U.S. and the largest player in Medicaid. 

The stock has underperformed lately, as CNC faces headwinds on the reimbursement front, including a reduction in its 2024 Medicare Advantage reimbursements. The market also seems to fear a potential loss of insured lives when Medicaid eligibility, which was expanded during the pandemic, gets redetermined in 2023-2024.

CNC hasn’t historically delivered consistent results compared to other premier managed care companies. More recently, the company upgraded its leadership ranks, including the addition of a CEO, CFO, and COO from better-managed companies with a track record of value creation. The company is undertaking a series of self-help efforts, including expense reductions, divesting noncore assets, share buybacks, and operational improvements.

Despite this, the stock trades at just 10 times 2023 earnings and 9 times 2024 profits. We consider that valuation too punitive for a company that we expect to continue growing EPS at a 12-15% compound annual growth rate.

Consumer Staples. We also established a new position in Ingredion Inc. (INGR), a global food products company that converts corn, tapioca, potatoes, grains, fruits, and vegetables into ingredients and biomaterials for the food, beverage, and other industries. Ingredion’s business has been under pressure in recent years. High-fructose corn syrup has been in secular decline because of shifting dietary preferences toward natural sweeteners. Moreover, inflationary pressures in recent years have put downward pressure on margins largely due to a spike in agricultural commodity prices.

However, INGR has begun demonstrating its ability to raise prices in order to offset rising production costs, albeit with a lag. We expect this trend to continue going forward, allowing for continued margin recovery. The company’s self-help drivers also give us confidence. Ingredion has been increasing its high-margin specialty segment as a percentage of its overall sales. Within the company’s lower growth ingredients segment, management is repurposing production capacity toward higher-value products.

INGR has historically traded at a 20-30% discount to its sector peers. Today, INGR trades at 7.9 times consensus EV/EBITDA over the next 12 months, which is around a 40% discount.

Value Bucket

Financials. Unlike the broader financial sector, which sank in the quarter, Interactive Brokers (IBKR), a fully digital brokerage platform, gained 14.24% in the first three months of the year. 

Interactive Brokers’ differentiated business model shined because the company’s management team built the business to avoid the two risks that came to the forefront for sector peers this quarter, credit and interest-rate risk. IBKR is a prime example of why analyzing businesses under multiple scenarios, both good and bad, is so important. In late 2021, when we began purchasing IBKR, the market was not pricing credit or interest-rate risk into the sector. Banks appeared optically “cheap” on P/E multiples, but after adjusting for downside risks, the upside versus downside potential was far more compelling in Interactive Brokers than in banks. Today that gap has narrowed, however, we continue to hold a position in IBKR given its lack of credit risk, which has yet to be fully priced into many banks.

IBKR enjoys industry- and sector-leading pre-tax margins thanks to its highly automated platform that drives scale efficiencies, which are partially passed on to customers in the form of attractive interest rates on cash balances. For this reason, clients have little incentive to move deposits as interest rates rise. IBKR’s management team has refused to take duration risk thereby significantly lowering the chances of a “run on the bank” scenario that proved disastrous for several banks this year. Credit risk is limited to margin loans that are over-collateralized and marked to market in real time thereby significantly reducing any loss given default.

Technology. We added to our existing position in Teradata Corp. (TDC), the largest provider of enterprise data analytics for complex workloads. Companies use TDC to predict a variety of events, such as when customers might switch to rivals, when parts are about to fail, or if transactions look suspicious for fraud.

While other enterprise IT companies have been reporting decelerating results, TDC continues to progress on growing recurring revenue from the cloud. The company’s hybrid/multi-cloud offering should position it well to help customers transition to the cloud. The stock remains undervalued, with a free cash flow yield above 9%. 


To the growing list of external uncertainties, the market was facing — including rising rates, inflation, and deteriorating earnings — we can now throw on a banking crisis. In our opinion, this is a time to seek the right balance between caution and the willingness to (selectively) capitalize on the rising fears that create better stock valuations. In an environment where tailwinds are difficult to count on, we will use our 10 Principles of Value Investing™ to help us strike this balance, focusing on company-specific catalysts, management teams and business strategies that can help drive operational execution and improved valuations. 

Fundamentally Yours, the Heartland Team. 

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

Vice President and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

CEO and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Troy McGlone

Troy McGlone

Vice President and Portfolio Manager

Fund Returns

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*Not annualized

Source: FactSet Research Systems Inc., Russell®, and Heartland Advisors, Inc.

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

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©2024 Heartland Advisors | 790 N. Water Street, Suite 1200, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

In the prospectus dated 5/1/2023, 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 4/5/2025, 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 1.16% for the investor class shares and 1.04% for the institutional class shares.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance for institutional class shares prior to their initial 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. To obtain performance through the most recent month end, call 800-432-7856 or visit heartlandadvisors.com.

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 Funds' prospectus. To obtain a prospectus, please call 800-432-7856 or visit heartlandadvisors.com. Please read the prospectus carefully before investing.

As of 3/31/2023, Centene Corporation (CNC), Ingredion, Inc. (INGR), Interactive Brokers Group Inc. (IBKR), and Teradata Corp. (TDC) represented 2.76%, 1.86%, 2.79%, and 4.88% of the Mid Cap Value Fund’s net assets, respectively.

Statements regarding securities are not recommendations to buy or sell.

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

The Mid Cap Value Fund invests in a smaller number of stocks (generally 40 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. 

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.

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

The Heartland Funds are distributed by ALPS Distributors, Inc.

The statements and opinions expressed in this article are those of the presenter(s). 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 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.

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.

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

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

Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indices. Russell® is a trademark of the Frank Russell Investment Group.

Data sourced from FactSet: Copyright 2024 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Active Investing is an investment strategy involving ongoing buying and selling actions by the investor. Active investors purchase investments and continuously monitor their activity in order to exploit profitable conditions. Buyback is the repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Charge-off is a debt deemed uncollectible by the reporting firm. It is written off and removed from the firm's balance sheet. Commercial and Industrial (C&I) Loan is a loan made to a business or corporation. Commercial and Industrial loans provide companies with funds that can be used for various purposes, including working capital or to finance capital expenditures such as purchasing machinery. Compound Annual Growth Rate (CAGR) is a year-over-year measure of growth during a specified period of time. It is calculated by dividing the ending value by the beginning value, then raising the quotient to the power of 1 divided by the total number of years, and subtracting 1. Corporate Credit Spread is the difference in yield between two bonds of similar maturity but different credit quality. Widening credit spreads indicate growing concern about the ability of corporate (and other private) borrowers to service their debt. Narrowing credit spreads indicate improving private creditworthiness. Cyclical Stocks cover Basic Materials, Capital Goods, Communications, Consumer Cyclical, Energy, Financial, Technology, and Transportation which tend to react to a variety of market conditions that can send them up or down and often relate to business cycles. Defensive Stocks include Health Care, Utilities, and Consumer Staples. These companies usually don’t suffer as much in a market downturn as they relate to basic needs. Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA) Ratio is a financial indicator used to determine the value of a company and is calculated by dividing the entire economic value of the company (enterprise value) by its earnings before interest, taxes, depreciation, and amortization (EBITDA). Federal Funds Rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. Free Cash Flow is the amount of cash a company has after expenses, debt service, capital expenditures, and dividends. The higher the free cash flow, the stronger the company’s balance sheet. Free Cash Flow Yield is calculated as the amount of cash a company has after expenses, debt service, capital expenditures, and dividends divided by either its current market price per share or enterprise value. Inflation Risk is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Liquidity is the degree to which an asset or security can be bought or sold in the market without affecting the asset's price. It is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets. Margin of Safety is a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. Passive Investing is an investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Price/Earnings (P/E) Ratio of a stock is calculated by dividing the current price of the stock by its trailing or its forward 12 months’ earnings per share. Risk on/Risk off Theory is an investment setting in which price behavior responds to, and is driven by, changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns. During periods when risk is perceived as low, risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived as high, investors have the tendency to gravitate toward lower-risk investments. Russell Midcap® Value Index measures the performance of those Russell Midcap® Index companies with lower price/book ratios and lower forecasted growth characteristics. All indices are unmanaged. It is not possible to invest directly in an index. Selection Effect of the Attribution Analysis is the portion of the portfolio excess return attributable to choosing different securities within groups from the benchmark. Senior Loan Officer Opinion Survey on Bank Lending Practices is a quarterly survey conducted by the Federeral Reserve which is completed by 75 banks consisting of 53 domestic and 23 foreign branches operating in the U.S. The survey gathers information on how officials feel about policy changes made, possible future policy changes and changes in supply/demand for certain products. Unemployment Rate measures the number of people actively looking for a job as a percentage of the labor force. Volatility is a statistical measure of the dispersion of returns for a given security or market index which can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security. 10 Principles of Value Investing™ consist of the following criteria for selecting securities: (1) catalyst for recognition; (2) low price in relation to earnings; (3) low price in relation to cash flow; (4) low price in relation to book value; (5) financial soundness; (6) positive earnings dynamics; (7) sound business strategy; (8) capable management and insider ownership; (9) value of company; and (10) positive technical analysis.