Heartland Value Fund 4Q19 Portfolio Manager Commentary

Executive Summary

  • In a market dominated by large-cap growth, the Fund finished the year up double digits. 
  • Stampedes into mega-cap momentum names have historically ended painfully.
  • We look forward to a new decade and a return of common sense.

“What does reversion to the mean, mean?”

—Bill Nasgovitz

A Year to Remember

In December, our Value Fund celebrated its 35th anniversary. We’re proud to report that since inception, the portfolio has delivered a compounded annual growth rate of better than 11.25%, outpacing its Russell 2000® Value Index benchmark.

The historic performance is particularly gratifying because it was achieved by following a single, disciplined philosophy—focus on small companies with solid growth prospects but buy them with an eye on the price paid. In a market where large-cap growth stocks dominated, the approach resulted in a 17.96% return this year.

Keeping it Simple

When it comes to investing jargon, sometimes, the simplest definition is the best. Take reversion to the mean. In our view, it’s a complicated way of saying a return to common sense. But as any value investor who’s lived through the last 10 years of mega-cap growth mania knows, simple isn’t always easy—a fact that became only clearer in 2019.

So, what is behind this disconnect between fundamentals and performance? Some of it, in our view, is fear of missing out, and a misguided belief that large companies are somehow safer bets. The thinking creates a stampede of assets into the largest companies by market cap, which in turn drives performance and valuations even higher. Like a sugar rush, the ride up can be exhilarating but when the music stops and companies can’t produce the growth required to justify lofty earnings multiples and $1 trillion-plus valuations, the downfall can be quick and painful.

As the chart below shows, the 10 largest companies in the S&P 500 have a combined market cap of MORE THAN 3X THE ENTIRE RUSSELL 2000® INDEX of small companies. It looks to us like we could be approaching one of those painful inflection points.


Capped Out?

Source: Furey Research Partners, LLC,  Standard & Poor’s, and Russell®, 12/1/1985 to 12/31/2019. This chart
shows the aggregate market cap for the ten largest companies in the S&P 500 Index divided by the total
market cap of the Russell 2000® Index.
Past performance does not guarantee future results.

While the stubborn lack of interest in small companies priced at attractive valuations has been frustrating, we’ve also welcomed the striking opportunities that have emerged as a result. As headwinds such as an unheard-of three-year ramp up in rates has reversed, and trade wars have started to subside, your portfolio has reaped some of the benefits of a market waking up to the bargains to be had in small-caps. The following are a few examples of the businesses that drove performance.

More than Where You Hang Your Hat

Low mortgage rates, strong employment and a massive, 90 million strong, millennial generation poised to buy into the American dream has been a boon for the housing market. During the past few years, your portfolio has benefited from this megatrend directly through a few select homebuilders, and indirectly from businesses like industry leading mortgage insurers Radian Group Inc. (RDN) and MGIC Investment Corporation (MTG).

Radian and MGIC were up sharply this quarter and for the year as the housing market for entry-level homes has been strong resulting in increased sales for both companies. The duo, with a combined $450 billion in insurance in force, has done an excellent job in strengthening credit underwriting since the financial crisis, in our view, and each should continue to benefit from current low mortgage rates.

Despite the strong performance, both are priced at less than 8X estimated earnings for an attractive earnings yield of 12%. Additionally, Radian trades at just 1.3X book value, while MGIC is at a lowly 1.2X book value. Given their growth prospects and attractive valuations, we continue to see opportunity for further appreciation.

Unheard of Success

As investors in small/micro-cap companies, our research analysts are on the lookout for niche businesses with unique models that provide a competitive advantage. The Bancorp, Inc. (TBBK) fits with this approach. The company, with $4+ billion in assets, may be one of the most widely used banks you’ve never heard of. As a white-label operation, TBBK provides behind-the-scenes banking services including prepaid gift and debit cards to more than 100 non-bank partners ranging from PayPal to Verizon. Through the card unit, the company can gather significant deposits at extremely low rates and then lend those assets out at open market rates. Additionally, TBBK generates high-margin fee income with each transaction completed using one of its cards.

TBBK came under regulatory scrutiny in 2014, relating to some issues in their prepaid card business. We sensed an opportunity and took a stake in the company when valuations created what we viewed as a favorable risk/reward dynamic.

Shares received a boost in early December when regulators lifted all remaining operating restrictions on the business, which frees up management to reinstitute a dividend. Despite the competitive advantage of low-cost assets, TBBK trades at a nearly 17% discount on tangible book value to its peers. We expect a bright future for the company and further appreciation for shares.

Joined Forces

Longtime holding SRC Energy Inc., (SRCI), an oil and gas producer, has been hampered by political challenges in Colorado and by a bottleneck in pipeline capacity to transport natural gas out the Denver-Julesburg (DJ) Basin where it operates. To enhance scale and efficiencies SRCI is merging with PDC Energy, (PDCE), to create the 2nd largest oil and gas producer in the DJ Basin. Negative political headlines notwithstanding, the combined entity should generate above peer group average debt adjusted growth with a robust free cash flow (FCF) yield.

This looks to us like a compelling value with a healthy balance sheet—net debt/EBITDA of just 1X—and shares trading at less than 3X pro-forma EBITDA (earnings before interest, taxes depreciation and amortization). The strong FCF should provide a potential return of capital optionality to shareholders via a stock buyback, debt repurchases and/or dividend initiation.


A Greener Future

In addition to traditional energy producers, we are delighted to find opportunities among green energy players such as Ameresco, Inc. (AMRC), a leader in improving energy efficiency.

The company designs, develops and installs projects that improve energy efficiency for commercial buildings. Ameresco also offers renewable sources of energy, electricity and green gas. For example, the company recently completed a major project at the Marine Corps Recruit Depot of Parris Island, South Carolina that resulted in significant reductions in energy and water usage.

Management has an impressive track record of growing sales—7% annual compounded over the past five years—and boosting EBITDA by 28% annually over the same span.

As one of the only publicly traded players in the field of optimizing energy usage, we believe Ameresco is well positioned to accelerate its growth as businesses and government agencies strive to achieve emission reductions.


The Price Paid Matters

Market activity of the past several months has us optimistic that a return to common sense may be taking root. High-flying unicorns with dubious profitability prospects such as WeWork have crashed back to earth and many recent initial public offerings have disappointed speculators.

We believe the valuations of your portfolio are compelling with solid sales and earnings growth which could exceed that of many ridiculously priced market darlings.
Thus, 2020 may be shaping up as a rare opportunity where Reversion to the Mean finally pays off.

Thank you for your patience, it’s been a long wait. We look forward to a new decade and return of common sense.

Value Fund Valuations

Heartland Advisors Value Investing Valuation Chart
Source: FactSet Research Systems Inc., Russell®, Standard & Poor’s, and Heartland Advisors, Inc., as of 12/31/2019
Price/Earnings and EV/EBITDA are calculated as weighted harmonic average. Certain security valuations and forward estimates are based on Heartland Advisors’
calculations. Certain outliers may be excluded. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change. All
indices are unmanaged. It is not possible to invest directly in an index. 


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Portfolio Management Team

Bill Nasgovitz

Nasgovitz is Chairman and Portfolio Manager of the Value Fund and its corresponding separately managed account strategy. He has 51 years of industry experience, 37 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.

Fund Returns


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Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
Investor Class
Institutional Class
Russell 2000® Value10.909.416.9210.566.994.7722.3922.398.49
*Not annualized

The inception date for the Value Fund is 12/28/1984 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 Value Fund are 1.10% and 0.92%, 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. Without such waivers and/or reimbursements, total returns may have been lower.

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As of 12/31/2019, Ameresco, Inc., MGIC Investment Corporation, PDC Energy, Inc., Radian Group Inc., SRC Energy Inc., and The Bancorp, Inc. represented 0.27%, 3.16%, 0.00%, 2.89%, 1.04% and 1.98% of the 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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Small-cap and large-cap investment strategies each have their own unique risks and potential for rewards and may not be suitable for all investors. Small-cap investment strategies emphasize the significant growth potential of small companies, however, small-cap securities, are generally more volatile and less liquid than those of larger companies. Large-cap investment strategies emphasize the stability of large companies, however, large-cap securities are more susceptible to momentum investments and may quickly become overpriced or suffer losses.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy emphasizes capital appreciation and typically carries a higher risk of loss and potential reward than a value investing strategy; a value investing strategy emphasizes investments in companies believed to be undervalued.

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The Value Fund primarily invests in small companies selected on a value basis. Such 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.