Heartland Mid Cap Value Fund 2Q21 Portfolio Manager Commentary

Executive Summary

  • Stock selection was strong in several sectors, and the portfolio finished the first half of the year ahead of its Russell Midcap® Value benchmark.
  • After a red-hot start to the year, investors looked for opportunities beyond the early beneficiaries of the economic reopening. 
  • The ongoing march higher for equities has provided many investors with what we view as a false sense of security.

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.

Second Quarter Market Discussion

Investors continued to bid up equities as COVID-19 infections plummeted, shutdown mandates were lifted, and consumers received another infusion of direct stimulus payments from the government. The speed and strength of the response to the winding down of the global pandemic was reflected in corporate financial results during the period, with the vast majority of businesses in the S&P 500 reporting sales and earnings that beat Wall Street estimates.
 
The optimism that led the major indices to flirt with new highs during the quarter continued a trend that has been in place for most of the past 12 months. While the buying mood remained during the period, the red-hot pace of the market moderated as investors harvested earlier gains and looked for opportunities beyond those businesses that would benefit quickest from a post-COVID recovery. 
 
There was plenty for investors to cheer during the period, but the persistence of the consumer-driven recovery may be challenged in the quarters ahead. As the chart below shows, the growth in retail sales over the past year has coincided with the amount of stimulus being doled out to consumers, as opposed to base wages. While consumer spending will likely remain robust in the short term as individuals splurge with roughly $1.5 trillion in excess income, we believe spending will begin to moderate and converge with long-term trends as government payments wind down.  
Spending Spree

Heartland Advisors Value Investing Personal Income vs. Retail Sales Chart
Source: U.S. Bureau of Economic Analysis and U.S. Census Bureau, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/. The data in this chart displays US dollars scaled to a value of 100 on a monthly basis from 6/30/2011 to 5/31/2021. Past performance does not guarantee future results.

Attribution Analysis

Stock selection was strong in several sectors, and the portfolio finished the first half of the year ahead of its Russell Midcap® Value benchmark. Holdings in Materials and Information Technology (IT) performed well on an absolute and relative basis while names in Consumer Discretionary were up single-digits and failed to keep pace with the average for those in the benchmark.  

Heartland Advisors Value Investing Materials Sector IconPutting on a fresh coat. The reawakened economy was a boon for businesses in the chemicals and metals industries, as mothballed manufacturers came to life. The portfolio’s holdings in the space outperformed the benchmark average and contained a top contributor, PPG Industries Inc. (PPG). 

PPG is the second-largest coatings supplier in the world and boasts the top market share in the industrial space, including auto, aerospace, and general industrial. The company is second only to Sherwin-Williams in the architectural coatings market.  

Shares of PPG sold off in early 2020 as global economies fell into recession. Given the company’s economically sensitive client base, earnings were hit by a broad-based decline in sales of coatings. While PPG’s stock rallied throughout the middle part of 2020 as fears about the economy subsided, it lagged sector peers throughout the winter because investors began to fear margin pressure fueled by rapidly rising input costs. This weakness presented us with an opportunity to sell a more capital-intensive portfolio holding that lacked pricing power and upgrade the portfolio with PPG, which we view as a higher-quality business. 

At the time of our initial investment, we were confident that any margin pressure caused by rising input costs would be offset over time by PPG’s pricing power. Our view was validated when PPG reported growing profit margins in its first-quarter earnings release for 2021. 

The company is also uniquely positioned to benefit from the shift toward electric vehicles (EVs). PPG has a robust portfolio of protective coatings for EVs.  Given PPG’s supply chain scale, we anticipate the company will see a material increase in content penetration due to the ongoing market adoption of electric vehicles, which should drive organic sales growth going forward.

Heartland Advisors Value Investing Financial Sector IconCash is king. Financials in the broad market continued to benefit from anticipation of rising rates and better than expected loan performance. The portfolio’s holdings in the sector outperformed on a relative basis and the group included FirstCash Inc, (FCFS), a top contributor for the period. 

Shares of FirstCash, which operates pawn stores in the U.S. and Latin America, jumped as the impact of COVID-19 stimulus checks began to fade and the demand outlook for pawn loans were expected to improve. We remain constructive on the business due to its high margins and view it as uniquely positioned to thrive should the financial resiliency of consumers soften. 

Heartland Advisors Value Investing Health Care Sector IconChecking lab results. Health care names in the portfolio posted tepid gains during the quarter, continuing a pattern from the beginning of the year. The group has been overlooked as investors flock to economically sensitive areas of the market, however we believe that attractive opportunities still exist in the space. Long-time holding Quest Diagnostics, Inc. (DGX), is one such example.

Quest, one of the largest diagnostic testing and services company in the U.S., has been mostly passed over as investors have reacted to a falloff in COVID-19 testing volumes, which had provided a boost to earnings. While we welcomed the spike in sales last year, we remained focused on our long-term investment thesis for the company. 

With shares trading at 11.8x estimated 2021 earnings, we believe investors are failing to recognize a positive inflection in Quest’s core sales. Additionally, the company is gaining market share from smaller players that should further enhance its scale. 

Quest should also benefit from industry trends including further consolidation, telemedicine, and a shift by managed care companies toward designating preferred lab networks. 

Portfolio Activity  

For more than a year, the markets have been operating in unchartered territory. From the havoc caused by mandated shutdowns and surges in COVID infections to the long-term effects—both planned and unanticipated—brought about by historic levels of fiscal stimulus, much of what has shaped the investment landscape over the past 18 months is without precedent. Instead of trying to predict how long the current boom will last, we have instead used recent volatility as an opportunity to uncover businesses where we believe valuations reflect a misunderstanding of risk and those businesses that are poised to succeed against a variety of backdrops. Recent portfolio addition Grand Canyon Education Inc. (LOPE) is an example of this approach.

Grand Canyon offers post-secondary education through traditional campus settings and a growing online presence. Its Orbis unit also provides healthcare curricula to leading universities across the country.

Grand Canyon reported weaker than anticipated enrollment data for its first quarter of 2021, causing the stock to sell off, which provided an attractive buying opportunity for the portfolio. We believe the shortfall is a temporary setback and shouldn’t tarnish the appeal of the business. We remain constructive on the company because it is a differentiated consumer holding that is less affected by the strength of the economy compared with other businesses in the sector. The company boasts high returns on capital and yet trades at less than 14x estimated 2022 earnings and offers a 7% free cash flow/enterprise value yield.  

Given Grand Canyon’s strong graduation and job placement performance, the company offers an attractive value proposition for prospective students. Consequently, we don’t believe soft enrollment trends will endure. Additionally, management continues to invest in its Orbis unit. While the investment is a headwind to earnings in the near-term, we believe it will result in additional profits as the unit gains scale.   

Outlook and Positioning

The ongoing march higher for equities has provided many investors with what we view as a false sense of security. After starting the year with an eye on fundamentals and valuations, buyers have cast aside concerns about price metrics and balance sheet strength as well as the potential for inflation to erode consumer demand going forward. 
 
Many areas of the market are trading at levels that leave little room for error. We believe a superior path to navigating the quarters ahead in a market that has become increasingly fragile requires a fundamental investment approach that incorporates valuations and financial strength, as well as seeks to identify catalysts that can result in a change in perception by investors.
 
Thank you for your continued trust and confidence.
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Portfolio Management Team

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager for the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund and it’s corresponding Mid Cap Value Strategy. He has 19 years of industry experience, 12 at Heartland.

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund, the Value Fund, and their corresponding Mid Cap Value and Small Cap Value Strategies. He also is President and Director of Heartland Funds. He has 21 years of industry experience, 17 at Heartland.

Troy McGlone

McGlone, CFA, is Vice President and Portfolio Manager for the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund and it’s corresponding Mid Cap Value Strategy. He has 13 years of industry experience, 7 at Heartland.

Fund Returns

6/30/2021

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Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
Mid Cap Value
Investor Class
10.57---13.7713.5557.0321.414.84
Mid Cap Value
Institutional Class
10.85---14.0613.8357.5021.564.95
Russell Midcap® Value9.72---11.7911.8653.0619.455.66
*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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©2021 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 5/1/2021, 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 1.21% for the investor class shares and 0.96% 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 6/30/2021, PPG Industries (PPG), FirstCash Inc. (FCFS), Quest Diagnostics, Inc. (DGX), and Grand Canyon Education (LOPE) represented 3.24%, 2.64%, 4.29%, and 0.95% 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 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. 

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.

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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 2021 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Earnings Per Share is the portion of a company’s profit allocated to each outstanding share of common stock. 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. 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. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index. 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.

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