Heartland Opportunistic Value Equity Strategy 1Q17 Portfolio Manager Commentary

Executive Summary

  • Security selection was positive in a majority of sectors but weakness in Health Care and Energy names contributed to the Strategy lagging its benchmark, the Russell 3000® Value Index, returning 1.78%† versus 2.99%.
  • Investors hedged their optimism by focusing on growth-oriented names, defensive areas, and larger businesses.
  • Expanded valuations have resulted in average companies trading at levels in line with high-quality counterparts.

First Quarter Market Discussion

Consumer and business confidence continued to surge but the major indexes took a more measured tone. Following a year-end rally for attractively valued businesses, investors hedged their optimism by focusing on growth-oriented names, defensive areas, and larger businesses.

The renewed emphasis on top-line expansion, we believe, reflects a growing debate over whether the economy has peaked or has room to grow. While we are not making an economic call, we expect the move toward growth names will be short-lived and value stocks will return to closing the performance gap versus their growth counterparts.

The Federal Reserve Board’s mid-March interest hike was widely expected and viewed as another step on the road to normalized rates. Commentary by the board was interpreted as a willingness by the Fed to take a slow and steady approach to tightening.

Attribution Analysis

Security selection was positive in a majority of sectors but weakness in the portfolio’s Health Care and Energy names lagged and the Strategy trailed its benchmark, the Russell 3000® Value Index. Industrial holdings led on the upside followed by Financials and Consumer Discretionary companies. Allocation decisions boosted performance moderately.

Heartland Advisors consumer discretionary iconNo place like home. PulteGroup Inc. (PHM), a national, diversified homebuilder, drove performance in Consumer Discretionary. The company reported better than expected results on improved sales. New home orders were also up 15% on a year-over-year basis.

The housing industry has benefited from consumer confidence, and single-family new home permits have surged. Our outlook on Pulte remains positive and we have been impressed with the progress management has made on improving returns on invested capital. However, we have trimmed our exposure to the company and some of our strong-performing building supply names to mitigate risk.

Heartland Advisors consumer discretionary iconSmall size—big impact. Following several months of firming prices, oil fell based on investor concerns about excess reserves being brought to market as well as questions about whether an agreement among members of the Organization of the Petroleum Exporting Countries to cut production would be renewed.

Companies ranging from producers to equipment manufacturers shared in the pain. Small businesses were particularly hard hit as investors seemed to look to larger names in hopes that size would offset volatility. Our smaller names in the space were no exception, and held back results.

Despite the setback, we remain constructive on holdings like Oil States International Inc. (OIS). The $1.7 billion energy equipment and services company generates most of its revenue from offshore related products for floating drilling platforms. With capital expenditures for deep-sea producers still soft, shares of OIS have struggled. We believe the market is overlooking the company’s superior technology and future revenue tied to completion business of land-based wells. If, as expected, the offshore market rebounds later this year, we believe the company will be well positioned to capitalize on the improvement.

Heartland Advisors industrials iconStrength through industry. The Strategy’s Industrial names were top performers on an absolute and relative basis. Kennametal Inc. (KMT), a name we bought last fall, continued its winning ways. The company is the third-largest maker of tools used in the metal working industry. Management continues to make progress on cost-cutting measures including closing underutilized facilities and reducing overhead by slashing its bloated marketing program. The strides resulted in higher than expected margins reported in Kennametal’s most recent earnings release. The stock also benefited from a continued uptick in industrial demand following several quarters of contraction.

We remain confident in the new CEO’s plan to reduce costs and reorganize the sales approach but have trimmed exposure to the company as valuations have climbed.

Portfolio Activity

Against a backdrop of political battles in Washington and elevated multiples in the major indexes, we remain focused on finding names trading at multiples that adequately compensate investors for risk. The surge to close out 2016 led to widespread valuation expansion and has resulted in average companies trading at levels that are in line with high-quality counterparts.

Our response has been to trim winners as valuations warrant and redeploy gains into higher-quality names with robust balance sheets and enduring franchises.

For example, we have sold some of our smaller banks and added to positions among larger financials. Small banks have had a strong run as investors anticipate a more normalized rate environment. The move has left valuations stretched, as shown, and we have moved into larger institutions with revenue generation opportunities beyond improved net interest margins.

A Pricey Play on Rates?

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary Banks Chart

Source: FactSet Research Systems Inc., 1/2/1995 to 3/31/2017
Small-cap banks are represented by securities in the S&P SmallCap 600® Index with the Bank industry classification, and Large-cap banks are represented by the same classification of securities within the S&P 500 Index.
Past performance does not guarantee future results.

Outlook and Positioning

The economic outlook remains sound, yet strong stock performance late last year has made valuations less compelling. Companies that have had strong runs over the past few months may face reduced upside until evidence of continuing business cycle strength emerges.

As such, we continue to comb through all sectors and industries looking for opportunities where we believe risk is mispriced. Our efforts have resulted in more early cyclical names on our watch list as well as some defensive names with idiosyncratic challenges weighing on valuations.

As investors continue to act on improved expectations, we are focused on striking a balance between maximizing upside potential by buying attractively valued businesses and mitigating downside risk by finding sound companies that are less volatile than their peers.

Portfolio Update

Effective April 30, Portfolio Manager and Heartland veteran David Fondrie will retire. This will mark the end of a multi-year transition for Dave into retirement. Dave began discussing his decision with leadership five years ago to ensure a seamless transition. Dave has been a valued member of the firm and an outstanding mentor to analysts and Portfolio Managers alike during his 20+ years with Heartland.

Following Dave’s retirement, the Opportunistic Value Equity Strategy will continue to be managed by Will Nasgovitz and Colin McWey, CFA. Will has served as a Portfolio Manager of the Strategy since May 2006, including serving as the Lead PM since May 2014. Colin was named co-PM in February 2015. The team is also supported by Analyst Troy McGlone, CFA.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager David Fondrie

David Fondrie

Fondrie, CPA, is Senior Vice President and Portfolio Manager of the Select Value Fund and its corresponding separately managed account strategy. He has 22 years of industry experience, all at Heartland.

Heartland Advisors Value Investing Portfolio Manager Colin McWey

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 15 years of industry experience, 8 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He also is CEO of Heartland Funds. He has 17 years of industry experience, 14 at Heartland.

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**10.256.2310.685.9921.741.781.78
Opportunistic Value Equity Composite (Net of Bundled Fees)
Russell 3000® Value7.125.9413.088.5819.972.992.99

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

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©2018 Heartland Advisors | 789 N. Water Street, Suite 500, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

†Composite return is net of advisory fees.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999.
**Provided as supplemental information.

Past performance does not guarantee future results.

In addition to stocks of large companies, the Opportunistic Value Equity Strategy invests in stocks of small- and mid-cap companies that are generally less liquid than large companies. The performance of these holdings generally will increase the volatility of the strategy’s returns.

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

Heartland Advisors, Inc. (the "Firm") claims compliance with the Global Investment Performance Standards (GIPS®). The Firm is a wholly owned subsidiary of Heartland Holdings, Inc., and is registered with the Securities and Exchange Commission. For a complete list and description of Heartland Advisors composites and/or a presentation that adheres to the GIPS® standards, contact the Institutional Sales Team at Heartland Advisors.

The U.S. dollar is the currency used to express performance.

As of 3/31/2017, PulteGroup, Inc., Oil States International, Inc., and Kennametal Inc. represented 1.5%, 1.3%, and 1.8% of the Opportunistic Value Equity Composite, 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 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.

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 as determined by Heartland Advisors may reference data from sources such as FactSet Research Systems Inc. or the Global Industry Classification Codes (GICS) developed by Standard & Poor’s and Morgan Stanley Capital International.

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.

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.

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

CFA® is a registered trademark owned by the CFA Institute.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, Inc.