Heartland Mid Cap Value Fund 4Q21 Portfolio Manager Commentary

Executive Summary

  • The Fund finished the year up more than 20% and kept pace with its benchmark.
  • Expectations that inflation was likely to be higher for longer, hurt growth-oriented businesses.
  • Faltering consumer confidence could create a ripple effect on Wall Street in the coming months.

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.

Fourth Quarter Market Discussion

Equities spent much of the quarter building on the strength they enjoyed throughout 2021. However, as the major indices reached new heights, investors grew wary of the long-term impact of the new wave of COVID-19 cases, stubborn inflation, and a growing consensus that the Federal Reserve would likely begin tightening monetary policy sooner than had been anticipated just a few months ago.

With the case for continued economic growth less certain, investors were quick to punish businesses and sectors that struggled to meet sales projections or were meaningfully impacted by supply chain disruptions. The expectation that inflation and interest rates were likely to be higher for longer, hurt growth-oriented businesses that had been riding high on optimism that they could deliver earnings expansion at some point in the future. 

The outlook from Main Street also began to fray as consumers faced sticker shock from the gas station to the grocery store. The faltering confidence, as highlighted in the chart below, could create a ripple effect on Wall Street in the coming months in economically sensitive areas of the market that have been elevated thanks to consumers flush with cash from government stimulus payments.

Price Worries

Heartland Advisors Value Investing Personal Income vs. Retail Sales Chart
Source: FactSet Research Systems Inc., Monthly data 1/30/1976 to 11/30/2021. The data in the chart represents consumer optimism (not seasonally adjusted) versus the actual CPI for Urban Consumers (seasonally adjusted). 'Consumer Sentiment, NSA, Percent – United States' was pulled from University of Michigan survey of Consumers. The indexes have a base of 1982-84=100 (the average of the monthly index values is 100 over the 36 months in 1982 through 1984). All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

As a result, we’ve been drawn to what we view as attractively valued companies that have prospects for operational improvement that are within their own control where investor euphoria has been more muted. 

Attribution Analysis

Security selection was mixed with holdings in Materials and Consumer Discretionary bolstering returns; however, the portfolio couldn’t overcome weakness in Financials and Information Technology, and the Strategy lagged the Russell Mid Cap® Value Index for the quarter. 

The portfolio finished the year up more than 20% and kept pace with its benchmark.

Heartland Advisors Value Investing Materials Sector IconA material advantage. While higher input costs and supply chain bottlenecks were a common theme across many industries, some areas were better suited than others to pass along price increases and navigate logistical challenges. The Materials sector is one example. 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 refinishing and original equipment manufacturing (OEM), aerospace, and general industrial. The company is second only to Sherwin-Williams in the architectural coatings market.

Shares of PPG lagged sector peers in early autumn after management warned that earnings would come in lower than expected for the third quarter and withdrew sales guidance for the period. Shortages of key coating ingredients have tightened inventories and caused costs to rise. Externally, customers, including those in the automotive industry, have slowed production as they grapple with their own supply chain issues. The moves have had a chain reaction resulting in a decline in orders for PPG products.

The company has responded to the above headwinds by aggressively raising per-unit pricing including a 6% increase in the fourth quarter and another hike planned for the first quarter of 2022. PPG’s stock responded favorably as real-time indicators suggest cost pressures may be at or near a peak.

Despite PPG being a provider of key components for its customers and uniquely positioned to benefit from the shift toward electric vehicles (EVs), the company trades at a discount to historical levels against both the S&P 500 and its peers.

Heartland Advisors Value Investing Financial Sector IconCOVID complications. Shares of many Health Care companies lagged as the continuing threat of COVID-19 dampened demand for elective medical procedures and health care providers struggled to maintain adequate staffing in the face of burnout and resistance to vaccine mandates. The Strategy’s holdings in the sector trailed the benchmark average, and the group contained a key detractor, Encompass Health Corporation (EHC).

Encompass provides inpatient rehabilitation services as well as home-based health and hospice care. Both businesses enjoy a competitive advantage over many of their peers and, we believe, are well positioned to grow organically, and acquire smaller competitors that could further economies of scale.

A labor shortage has taken a toll on sales and profit margins at Encompass as the company struggles to fill positions in a challenging environment for nursing wages and availability. Revenues have also been hurt by a slowdown in elective surgeries performed, which results in a smaller pool of patients in need of rehabilitation services.

When we took a stake in Encompass late in the summer of 2020, we recognized that COVID-related headwinds could endure longer than anticipated. However, the team believes the current challenges will eventually fade as enhanced nurse recruiting outreach helps mitigate staffing pressures while COVID-19 containment and treatment efforts gain traction. With shares producing an 8% free cash flow yield and trading at just 9x 2022 enterprise value/earnings before interest, taxes, depreciation, and amortization, we believe our patience will be rewarded. 

Heartland Advisors Value Investing Health Care Sector IconBuck up. The resiliency of the consumer has been a driving force over the past 18 months as the economy rebounded from early COVID-19 lows. While inflation may be a challenge to spending habits in the new year, the portfolio benefited from holdings that we believe are less economically sensitive and should continue to perform as government stimulus payments fade. Dollar Tree Inc. (DLTR) provides an example of our approach. 

Dollar Tree owns two brands, Dollar Tree and Family Dollar, each operating roughly 8,000 locations in the United States and Canada. The Dollar Tree brand has historically operated a true dollar store with its locations offering products at the fixed $1 price point. 

The Family Dollar unit was acquired in 2015 and sells mostly daily essentials to lower-income customers. The retailer was an underperforming asset when Dollar Tree acquired the business. Over the past six years, management has invested significantly in remodeling Family Dollar stores and improving merchandise to raise profit margins closer to those of industry peers.

Shares of Dollar Tree were up to close out 2021 as investors applauded management’s move to raise the price point of goods sold at Dollar Tree to $1.25, which is expected to offset inflation pressures for the company and help it maintain margins on the goods it sells. Additionally, as headwinds have begun to emerge for consumers, the company’s mix of products, in our view, should produce more resilient sales among its cost-conscious customers.

As shares have appreciated, we’ve trimmed the portfolio’s stake in the business to manage exposure. However, we continue to maintain a position on the belief that shares are still priced at a discount to their historical average based on our 2022 earnings estimates. 

Portfolio Activity  

The run-up in equity prices over the past year and a half has narrowed the pool of attractively valued businesses. Economically sensitive areas of the market, in particular, have seen valuations stretched—but the impact of investor exuberance is evident in share prices of companies throughout the broader market. In our view, the elevated valuations commanded by many stocks have heightened risks and dampened upside potential.

In response to this backdrop, we continue to focus on finding and owning companies that are poised to succeed against a variety of backdrops or those that are priced at significant discounts to peers regardless of the sector or industry. Recent addition Expedia Group, Inc. (EXPE) is an example of the type of business we’ve found attractive.

Roam with the gnome. Expedia is an online travel agency that operates under multiple brands including Expedia.com, Hotels.com, Orbitz, Hotwire, and VRBO. The company has grown over the years through a combination of acquisitions and capitalizing on the trend of consumer preferences toward booking vacation plans via the internet as opposed to through traditional travel agents. 

Following years of acquisitions that left Expedia’s cost structure inflated, in 2019, a new management team was brought in to streamline operations and shutter unprofitable businesses. As the company was executing their turnaround plan, COVID-19 disrupted the global travel industry and sent Expedia’s business in a tailspin. 

As the travel industry emerged from the depths of COVID-19, management has executed on its cost streamlining initiatives while finding new ways to optimize the cost structure in light of a more challenging travel industry backdrop. As vacation activity continues to recover, we believe the positive impact of initiatives to cut variable costs will become clearer. 

Although it remains unclear how long it will take for the leisure travel to fully recover, we expect the industry to benefit from several years of pent-up travel demand as the pandemic subsides. Despite the promising outlook for Expedia, shares trade at just 9X normalized earnings before interest, taxes, depreciation, and amortization. 

Outlook and Positioning

As companies adjust to growing economic headwinds, volatility could remain elevated during the coming quarters. In fact, the emergence of the Omicron COVID-19 variant provides a vivid example of how fluid the economic narrative has become and how quickly today’s market darlings can become tomorrow’s dogs.

While we cannot predict when economic growth will falter, our recognition that it is a distinct possibility serves as a reminder to stick with our time-tested process. As such, the team is steadfast in its focus on finding businesses with attractive valuations, balance sheet strength, and catalysts that can result in a change in perception by investors. This approach should result in a favorable risk-reward profile in the quarters and years ahead. 

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Colin McWey

Vice President and Portfolio Manager

Will Nasgovitz

CEO and Portfolio Manager

Troy McGlone

Vice President and Portfolio Manager

Fund Returns


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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
Mid Cap Value
Institutional Class
Russell Midcap® Value10.11---11.2219.6228.3428.348.54
*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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©2022 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 5/1/2022, 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 4/5/2024, 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 1.17% for the investor class shares and 0.98% 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 12/31/2021, Encompass Health Corporation, Expedia Group, Inc., Dollar Tree Inc., and PPG Industries Inc. represented 2.98%, 2.29%, 1.23%, and 3.25% of the Mid Cap Value Fund’s net assets, respectively. Sherwin-Williams Co. was unowned.

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 2022 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) measures a company’s financial performance. It is used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. 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). Consumer Price Index (CPI) is the most widely used measure of consumer price inflation. The CPI measures the average change over time in the prices paid by urban consumers for goods and services. The Bureau of Labor Statistics (BLS) of the U.S. Department of Labor collects the CPI price information and calculates the CPI statistics. Consumer Sentiment Index is a telephone survey conducted by the University of Michigan Consumer Research Center, which phones 500 consumers to ask their opinion on personal finances and business conditions. Consumers are asked five questions concerning household financial conditions and their expectations for household financial conditions in one year; their expectations for business conditions in one year as well as expectations for the economy in five years, and their buying plans. This release provides an early indication of consumer expectations that are a leading indicator for the business cycle. The monthly survey has a moderate impact on the financial markets because if consumer confidence declines, then consumer spending is likely to weaken. The data is seasonally adjusted. With consumer spending making up two-thirds of gross domestic product, consumer behavior is closely watched. 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. Original Equipment Manufacturer (OEM) is a company whose goods are used as components in the products of another company, which then sells the finished item to users. 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.