Heartland Select Value Fund 2Q19 Portfolio Manager Commentary

Executive Summary

  • The Fund mildly lagged its benchmark, the Russell 3000® Value Index, returning 3.23% versus 3.68%.
  • An escalation of long-simmering trade tensions added to concerns that the economy was running out of room to expand.
  • We believe it’s important to avoid jumping into positions that have only recently come under pressure.

Second Quarter Market Discussion

An escalation of long-simmering trade tensions added to concerns that the economy was running out of room to expand. Investors responded with increased caution that led to a surge in volatility and left the major indices flat for the quarter, yet still up for the first half of the year.
This more risk averse attitude provided a tailwind to defensive areas as well as companies that are domestically focused. Still, balance sheet strength remains largely overlooked by investors. Signs are emerging, however, that heavily leveraged companies are no longer getting the benefit of the doubt when they disappoint on earnings or guidance. 
Treasury yields tumbled on expectations that the Federal Reserve was likely to cut interest rates by year end. Yet investors showed some selectivity when looking for sources of yield. While real estate investment trusts (REITs) remained a go-to space for income hungry investors, as shown, many avoided real estate tied to the beleaguered retail sector.
More Than Just Location
Heartland Advisors Value Investing REIT Chart
Source: FactSet Research Systems Inc., 12/31/2010 to 6/28/2019
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Past performance does not guarantee future results.

Attribution Analysis

Security selection was mixed, with holdings in Health Care and Consumer Staples boosting relative results, but the portfolio lagged its benchmark, the Russell 3000® Value Index, for the quarter. Our holdings in Real Estate also contributed to relative performance while weakness in Financials detracted.
Heartland Advisors Value Investing Health Care Sector IconNice checkup. The portfolio’s Health Care holdings were up solidly, and the group contained a top contributor, Dentsply Sirona Inc. (XRAY), a manufacturer of health care technology and supplies with an emphasis on dental products. 
We initiated a position in Dentsply in mid-2018 after the company saw its sales growth soften and margins erode due to a lack of management focus.  A new CEO was brought in at the time, and we believed fresh management could instill a renewed sense of urgency to the business. Since then, the company has undertaken cost-cutting initiatives and plans to divest lower margin units with an expectation the moves will result in up to $225 million in annual savings by 2021. 
As the company continues to make progress on reducing costs and streamlining its business units, we expect margins to increase and the stock to trade more in line with medical device peers.
Heartland Advisors Value Investing Consumer Staples Sector IconOld reliable. Consumer Staples stocks faced headwinds as the economic outlook became more clouded. Our holdings in the space fared better than the benchmark average and included a top contributor, Walmart Inc. (WMT). The business remains an exception to the shaky retail industry. The company posted its largest jump in same-store sales in nine years and has now posted 19 consecutive quarters of growth in comparables. 
Walmart’s ability to grow same-store sales and its ongoing focus on inventory management has been impressive and has allowed the company to rollout a competitive on-line offering. While valuations have increased from the meaningfully discounted levels of late 2015—when we first took a stake in the company—we believe there remains room for further upside. 
As the world’s largest retailer, Walmart is well positioned in our view to successfully compete with Amazon.com, Inc. (AMZN) and maintain market share at a time when many smaller competitors can’t make investments necessary to stay relevant. 
Heartland Advisors Value Investing Financials Sector IconFinancial pressure.  As debate swirled around the timing of the next rate move by the Federal Reserve, the Financials sector edged upwards. The portfolio’s holdings in the space lagged yet we remain patient with many of our long-time holdings.  
Bank of New York Mellon Corporation (BK), one of the big three custody-bank pure plays in the U.S., was off as revenue came under pressure from tighter net interest margins and a slowdown in capital markets business. We view the set back from the perspective of our seven-year investment in the company. 
During the time we’ve owned Bank of New York, its margins have increased by almost one-third to 34%. Sales have increased by roughly $1.5 billion during the same period. Management was able to keep costs in check by reducing large-ticket expenses such as maintaining the company’s sizeable real estate footprint. We believe recent investments in technology, which have led to a bump up in costs, will pay for themselves by driving even greater efficiency and margins will rebound in the periods ahead.
With shares trading at a 10% discount to the sector vs. its historical average of a 10% premium, we believe Bank of New York remains an attractive long-term opportunity.

Portfolio Activity

We have sought to maintain a balanced approach in the face of heightened volatility by selling names that are approaching our estimates of intrinsic value and opportunistically buying market leaders we view as being oversold. 
For example, we initiated a position in FedEx Corporation (FDX), a global shipping and e-commerce company. Shares have been under pressure as management has lowered guidance three times since December in response to slowing global economic growth. As long-term investors, we are looking past what we view as a temporary slowdown and, instead, focusing on long-term prospects and valuations.
FedEx should be able to take significant market share from its primary competitor due to its more flexible workforce. We also expect that integration of its acquisition of European shipper TNT Express, which got off to a rocky start, will begin to gain traction and lead to greater sales and margins globally. 
Despite its strong long-term prospects, shares of FedEx trade at a 40% discount to their historic average based on forward price-to-earnings multiples.

Outlook and Positioning

Softening economic data and uncertainty about when or how ongoing trade disagreements will be resolved, highlight the need for a patient, disciplined investment approach. We believe it’s important to avoid jumping into positions that have only recently come under pressure, even if their valuations have improved. Buying a name too early carries a substantial downside risk. In our view, the prudent course is to get past a fear of missing out on upside potential and stay focused on company-specific factors. 
While volatility can be challenging to navigate, it can also provide opportunity to upgrade the quality of a portfolio as well as to find attractive bargains on lesser known names that may have stumbled. This dynamic should benefit active investors who focus on fundamentals and identifying catalysts for positive change.
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Portfolio Management Team

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 18 years of industry experience, 11 at Heartland.

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 20 years of industry experience, 16 at Heartland.

Troy McGlone

McGlone, CFA, is Vice President and Portfolio Manager of the Select Value Fund and its corresponding separately managed account strategy. He has 12 years of industry experience, 6 at Heartland.

Fund Returns

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*Not annualized

The inception date for the Select Value Fund is 10/11/1996 for the investor class and 5/1/2008 for the institutional class.

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In the prospectus (pdf) dated 5/1/2020, the Gross Fund Operating Expenses for the investor and institutional classes of the Select Value Fund are 1.25% and 1.02%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class’ “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/reimbursement may be discontinued at any time. 

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As of 6/30/2019, Amazon.com, Inc., Bank of New York Mellon Corporation, Dentsply Sirona Inc., FedEx Corporation, and Walmart Inc. represented 0.00%, 1.22%, 2.56%, 1.06%, and 2.04% of the Select 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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Because of ongoing market volatility, performance may be subject to substantial short-term changes.

FTSE NAREIT Equity Shopping Centers Index is a free float adjusted market capitalization weighted index that includes all tax qualified REITs listed in the NYSE, AMEX, and NASDAQ National Market.

MSCI US REIT Index is a free float-adjusted market capitalization index that is comprised of equity REITs. The index is based on MSCI USA Investable Market Index (IMI) its parent index which captures large, mid and small caps securities. With 152 constituents, it represents about 99% of the US REIT universe and all securities are classified in the REIT sector according to the Global Industry Classification Standard (GICS®). 

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In addition to stocks of large companies, the Select Value Fund invests in small- and mid-sized companies that are generally less liquid and more volatile than large companies. The Fund also 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.

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