Heartland Value Plus Fund 3Q20 Portfolio Manager Commentary

Executive Summary

The portfolio remains meaningfully ahead of its benchmark, the Russell 2000® Value Index, through the first nine months of the year.
Investors gravitated toward high-beta and highly leveraged businesses.
Government deficits and private sector leverage shot into unprecedented territory.
Stimulus has cushioned some of the economic damage from COVID-19, but long-term expansion could be tepid.

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.

Third Quarter Market Discussion

During much of the period, the major indices built on strength from late Spring as investors charged head-first into equities despite an uncertain outlook for the global economy. The momentum stalled in the final few weeks as investors grew wary of extended valuations for many areas of the market. The risk-on stance in place for most of the summer was fueled by an accommodative Federal Reserve and ongoing effects from the trillions in relief dollars pouring out of Washington D.C. over the past several months.

The prevailing sense that the Federal Reserve would backstop even the weakest businesses, led investors to what appeared to be riskier names in the market and bid up high-beta and highly leveraged businesses. Traditional safety nets such as strong balance sheets or attractive valuations were an afterthought and reasonably priced businesses lagged.

While Wall Street showed a willingness to look past debt levels, government deficits and private sector leverage shot into unprecedented territory raising questions about the sustainability and true underlying strength of the U.S. economy. If the economy is less robust than conventional wisdom suggests, many of the richly valued businesses with rosy growth forecasts could stumble in the quarters ahead.

Nonfinancial Debt as a Share of GDP

Source: Bloomberg L.P., 12/31/2015 to 12/31/2020 Raw industrials are represented by the Commodities Research Bureau BLS US Spot Index Raw Industrials Subdivision. Past performance does not guarantee future results.

Attribution Analysis

The portfolio remains meaningfully ahead of its benchmark, the Russell 2000® Value Index, through the first nine months of the year. An underweight to and selection in Energy boosted relative results, however, couldn’t overcome weakness in Health Care and the portfolio lagged during the period.

Given the appetite investors showed for leveraged, high-beta names for much of the quarter, we believe results, while disappointing, should be viewed in the context of one data point in a multi-year investment horizon. From this perspective, the portfolio, in our view, is prudently positioned, and investors should reap the benefits of our focus on balance sheet strength and internally driven catalysts over the long-term.

Narrowing the spectrum. While investors spent much of the period bidding up businesses based on sales growth expectations, the portfolio reaped the benefits of some holdings that were driving an improved outlook through self-help measures. Spectrum Brands Holdings (SPB), a household products company, is one such example.

Spectrum sells a variety of home goods through its market-leading brands including Kwikset, Black and Decker, Pfister and Remington. Of the company’s $3.8 billion in annual sales, roughly 80% are driven by its top 15 brands. During the past 18 months, management has undertaken an initiative to exit non-core business lines such as auto care and batteries, reduce debt and improve efficiencies. These efforts have begun to produce results and sales figures have exceeded expectations during the COVID-19 downturn.

We believe Spectrum is in the early innings of its transformation and should also see continued organic sales growth as it invests proceeds from divestitures into its business. Despite recent improvements in its share price, the company still trades at a meaningful discount to its peers on an enterprise value/earnings before interest, taxes, depreciation and amortization basis.

Add hock. An underweight to Financials boosted relative results. Stringent regulations and a low rate environment have created an undifferentiated landscape in the Banking industry. In response, the team continues to focus on identifying standout institutions that can benefit from management initiatives or serve untapped markets. For example, we added to our stake in First Cash Financial Services, Inc. (FCFS), a pawn store operator with locations in the U.S. and Latin America.

Shares of First Cash Financial were down as COVID-19 fears roiled the markets earlier this year. The stock has continued to languish based on concerns that additional stimulus checks will erode future demand for pawn loans. Our thesis is that unemployment will remain elevated and political compromise is unlikely before the Presidential election and thus demand for pawn loans will increase near-term.

Portfolio Activity

The business climate remains cloudy. As such, we continue to seek companies trading at attractive valuations, with strong management teams and that have avenues to succeed under multiple scenarios. For example, we initiated a position in Ralph Lauren Corp. (RL), a global lifestyle company that sells clothing, accessories and home goods.

Shares of Ralph Lauren tumbled earlier this year during the COVID-19 selloff. The stock has yet to fully recover as investors continue to cast a skeptical eye toward apparel companies and retail brands in the Consumer Discretionary space. While the global pandemic has been a severe blow to the beleaguered apparel industry, we view Ralph Lauren as a relative winner in the space.

Ralph Lauren is a best-in-breed brand with high gross profit margins and a loyal clientele. Management is using the disruption from the pandemic to accelerate cost-cutting efforts and pivot to an e-commerce growth model. With approximately $800 million in net cash on its balance sheet, we believe Lauren is well prepared to weather current headwinds in retail and should increase sales and earnings in the long-term. Despite our favorable outlook, shares are trading at roughly 6x enterprise value/next year’s earnings before interest, taxes, depreciation and amortization.

Outlook and Positioning

COVID-19 is likely to cast a shadow over the global economy for several years. Government stimulus has cushioned some of the immediate effects of cratering production and demand, but we expect the long-term expansion to be tepid.

Many investors have interpreted government intervention as an “all clear” to load up on shares of companies with shaky balance sheets, operating in declining industries and those with questionable capital allocation strategies. While those types of companies soared during much of this year, we believe it is a short-sighted approach fraught with risk.

Instead, we are taking a long-term view by investing in businesses that we believe may be well positioned to drive free cash flow growth and those with the financial strength to potentially weather long-term uncertainty caused by the pandemic. We believe this tactic could produce a portfolio of companies that may come out on the other side of the current environment in a much stronger position.

Thank you for the opportunity to manage your capital.

Statements regarding securities are not recommendations to buy or sell.

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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 25 years of industry experience, 22 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.

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Fund Returns

9/30/2020

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	Since Inception (%)	20-Year (%)	15-Year (%)	10-Year (%)	5-Year (%)	3-Year (%)	1-Year (%)	YTD* (%)	QTD* (%)
Value Plus Investor Class	9.01	8.32	6.04	5.91	6.75	0.27	-6.45	-12.49	-0.29
Value Plus Institutional Class	9.13	8.48	6.25	6.17	6.96	0.49	-6.24	-12.33	-0.23
Russell 2000® Value	8.42	7.40	4.93	7.09	4.11	-5.13	-14.88	-21.54	2.56

*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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In the prospectus dated 5/1/2021, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.23% and 0.97%, 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.

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

As of 9/30/2020, Heartland Advisors on behalf of its clients held approximately 2.66%, 2.03, and 3.80% of the total shares outstanding of FirstCash, Inc., Ralph Lauren Corporation Class A, and Spectrum Brands Holdings, Inc., of the Value Plus Fund’s net assets, respectively.

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. There is no assurance that dividened paying stocks will mitigate volatility.

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.

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