Heartland Value Plus Fund 2Q20 Portfolio Manager Commentary

Executive Summary

  • The portfolio remains meaningfully ahead of its benchmark, the Russell 2000® Value Index, for the first half of the year.
  • Market breadth was weak with shares of many companies failing to recoup previous losses.
  • Hopes of a V shaped economic recovery prompted equity investors to stampede back to equities.
  • We remain focused on businesses that are poised to be disrupters in their fields and that have strong cash flows.  

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public 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.

Second Quarter Market Discussion

With the Federal Reserve signaling it was willing to backstop the economy and prop up even the weakest businesses, investors flocked back to the equity markets. The stampede was heightened by hopes of a V shaped economic recovery, which was based on economic data and earnings reports that were less bad than expected.

The risk-on sentiment was in stark contrast to much of the first quarter when widespread COVID-19 fears roiled the markets. The speed and strength of the rebound paused late in the period as investors grew wary of a second wave of new virus infections across several states.

While the move higher for the quarter was a welcome relief for battered portfolios, a closer look at winners and losers painted a less optimistic picture. Breadth was weak with shares of many companies failing to recoup previous losses. Additionally, as shown below, shares of businesses with low returns on equity, as a whole, materially outperformed their higher quality counterparts. Lower quality names often lead in rallies following selloffs, but the magnitude of the bounce back was noteworthy.

Dash to Trash?
 

Source: FactSet; FTSE Russell; Jefferies. This chart shows companies held in the Russell 2000 Index. The 2020 bear market is representing data gathered during 1/16/2020 to 3/18/2020. The average bear market data is calculated based on bear markets taking place during 12/31/1985 to 6/18/2020. Bottom was on 3/18/2020. The average 3-month after bear market data is calculated based on 3 months following each bear market taking place during 12/31/1985 to 6/18/2020. Return on equity (ROE) measures the net income after taxes a firm is able to earn as a percentage of shareholders’ equity. A bear market occurs when the price of a group of securities is falling or is expected to fall. 

Attribution Analysis

The portfolio remains meaningfully ahead of its benchmark, the Russell 2000® Value Index, for the first half of the year. However, strong stock selection in several sectors couldn’t overcome weakness in Health Care and Materials and the portfolio lagged during the quarter. 

Given the low-quality nature of the recent rally, results, while disappointing, are not surprising. We believe, however, that the portfolio is prudently positioned, and investors should reap the benefits of our focus on balance sheet strength and internally driven catalysts over the long-term. 
 
Disruptors wanted. As part of our quest to find businesses with opportunities to improve sales and earnings, we have sought companies that are taking a differentiated path from competitors. We believe these disruptors will be well suited to compete in the aftermath of the global pandemic. Sonic Automotive Inc. (SAH), a top performer for the period, is an example of our thinking.

Sonic is one of the country’s largest automotive retailers, with 95 franchises in 12 states. The business operates in two segments—traditional new and used car sales locations and its EchoPark unit that operates standalone used cars outlets. Shares of the company were up sharply during the quarter as auto sales surged after a dismal first quarter due to COVID-19.

We welcomed the improvement but view Sonic as attractive for the long haul. Specifically, in our view, the company has one of the strongest balances sheets in the industry, a great new car dealer franchise and EchoPark offers a differentiated approach providing it exceptional growth potential in the fragmented and inefficient used-car market. 
 
On the mend?  Health Care, driven by Biotech shares, posted solid gains in the benchmark. Our names failed to keep pace and contained a key detractor, Cross Country Health Care Inc. (CCRN), a health care staffing company specializing in traveling nurses.

Shares of Cross Country were under pressure as demand for health care workers was down due to “elective” procedures being halted during COVID-19. As restrictions have eased and procedures have ramped up, the company has begun to see a rebound in revenue. We expect top-line trends to continue to improve and have been encouraged by meaningful share purchases made by company executives this year.

Solid wood.  Traditionally, rich valuations and lackluster growth prospects have created unique challenges for finding compelling opportunities in the REIT sector. However, we have been able to find attractive candidates in the space by looking in areas beyond retail or commercial real estate. This approach benefitted the portfolio as our holdings in the sector, led by Potlatchdeltec Corp (PCH), outperformed on a relative basis.

Potlatchdeltec owns significant timberland acreage and operates wood mills across the U.S. Shares of the company were up after reporting solid results and minimal impact on its operations due to social distancing. Additionally, Potlatchdeltec was one of the few REITs to maintain its dividend during the period.

We believe shares of Potlatchdeltec should benefit going forward given strong housing demand and stable lumber prices. The company also has strong capital allocation policies in place and has a history of buying back shares when they trade at a discount to net asset value (NAV). 

Despite the strong outlook for company, shares are trading at a 25% discount to NAV.  
 

Portfolio Activity 

The far-reaching economic impact caused by COVID-19 is likely to play out for several years. The pandemic will likely change the way consumers shop, where they eat and how they work. Against this still evolving backdrop, we have sought to identify companies trading at attractive valuations that have avenues to succeed under multiple scenarios. Commoditized areas of the market, such as in Energy, could continue to face headwinds due to excess supply and diminished demand. As such, we have struggled to find compelling opportunities in the space, and it remains an underweight for the portfolio.  


Outlook and Positioning

The flood of stimulus unleashed by the U.S. government and its willingness to prop up even the weakest businesses has caused investors to lose their inhibitions. As a result, shares of companies with shaky balance sheets, operating in declining industries and those with questionable capital allocation strategies, have been snapped up. While those types of companies soared during the most recent period, we believe it is a short-sighted approach doomed to failure.

Instead, we are investing in businesses that are well positioned to drive free cash flow growthand those that are financially strong, in our view. We believe this tactic is the most prudent approach given the current environment. 

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Bradford A. Evans

Evans, CFA, is Senior Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 24 years of industry experience, 21 at Heartland.

Andrew J. Fleming

Fleming, CFA, is Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 11 years of industry experience, 8 at Heartland.

Fund Returns

6/30/2020

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Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
Value Plus
Investor Class
9.118.476.426.752.832.66-6.35-12.2314.70
Value Plus
Institutional Class
9.238.636.637.013.042.89-6.14-12.1314.77
Russell 2000® Value8.407.654.977.821.26-4.35-17.48-23.5018.91
*Not annualized

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

The inception date for the Value Plus Fund is 10/26/1993 for the investor class and 5/1/2008 for the institutional class.

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©2020 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 (pdf) dated 5/1/2020, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.19% and 0.98%, 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.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public 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. 

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 prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

As of 6/30/2020, Heartland Advisors on behalf of its clients held approximately 1.60%, 3.69% and 3.83% of the total shares outstanding of Cross Country Health Care Inc., Sonic Automotive Inc., and Potlatchdeltec Corp, of the Value Plus Fund’s net assets, respectively. 

Statements regarding securities are not recommendations to buy or sell.

Portfolio holdings are subject to change without notice. Current and future portfolio holdings are subject to risk.

The Value Plus Fund invests in small 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 70) 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.

The Value Plus Fund seeks long-term capital appreciation and modest current income.

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The Heartland Funds are distributed by ALPS Distributors, Inc.

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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Data sourced from FactSet: Copyright 2020 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

Bear Market occurs when the price of a group of securities is falling or is expected to fall. 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. 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. 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. Return on Equity is a measure of the net income after taxes that a firm is able to earn as a percent of stockholders equity. Russell 2000® Value Index measures the performance of those Russell 2000® 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.

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

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