Heartland Opportunistic Value Equity Strategy 2Q17 Portfolio Manager Commentary

Executive Summary

  • Security selection in Information Technology (IT) and Materials contributed to relative performance but weakness in Industrials caused the Strategy to lag its benchmark, the Russell 3000® Value Index, returning 0.79%† versus 1.29%.
  • Against a murky economic outlook, investors gravitated toward growth-oriented names, defensive areas, and larger businesses.
  • Our emphasis is on holding names with company-specific catalysts that can be achieved independent of the macro economic environment.

Second Quarter Market Discussion

Investors spent the quarter balancing a murky economic outlook against fears of being left behind from the ongoing equity market surge. Their response was to bid up what has worked for the past few years—growth stocks and so-called defensive areas of the major indices including shares of larger companies.
The conflicted view was reflected in the mix of assets that rallied. The growth-oriented NASDAQ surged to new highs at the same time bonds rallied, and gold, a traditional safe haven, hit levels not seen in months. 
The emphasis on top-line expansion and less cyclical areas of the market, 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, as shown, history suggests that value cycles like the one that began to emerge late in 2016 tend to endure for more than a few months. As such, we anticipate the latest move toward growth names will be short-lived and valuations will once again be a focus for investors. 
Setting Up for a Value Run?
Russell 3000® Value Index Less Russell 3000® Growth Index
Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary Value vs Growth Chart
Source: Furey Research Partners, LLC and Russell®, 12/31/1978 to 6/30/2017, annualized return over rolling 10-year periods
Additional information for indexes shown at end of commentary. All indexes are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Attribution Analysis

Security selection was mixed and weakness in the portfolio’s Industrials and Consumer Discretionary names caused the Strategy to lag its benchmark, the Russell 3000® Value Index. Consumer Staples boosted results. The price of oil slumped, and Energy was the worst performing group in the Index. The portfolio’s names in the sector were down but outperformed on a relative basis. Allocation decisions contributed positively to returns. 
Heartland Advisors value investing portfolio commentary consumer discretionary sector iconA stall for the mall. The portfolio’s Consumer Discretionary names lagged as brick and mortar retailers continued to face fallout from consumers migrating to the internet. However, the group contained a top contributor for the Strategy.
Retail giant Wal-Mart Stores, Inc. (WMT) was up after posting its 11th consecutive quarter of same store sales growth. The department store also continues to see improved online sales and believes its future gains will be driven by e-commerce.
As the world’s largest retailer, we believe Walmart is in a unique position to successfully compete with Amazon.com (AMZN) and maintain market share at a time when many smaller competitors are unable to make the necessary investments to stay relative.
Heartland Advisors value investing portfolio commentary finacials sector iconFalling off the wagon. The Strategy was underweight to Financials and the group contained an industry laggard. Wells Fargo & Company (WFC) was essentially flat despite reporting earnings that fell short of analysts’ expectations. Weakness in the company’s Community Bank division overshadowed double digit profit increases in the Commercial Bank and in Wealth Management divisions. Earnings were also held back by a slowdown in mortgage originations as a result of rising interest rates.
We remain bullish on the company and believe expense-cutting efforts will bolster the bottom line and provide cash for growth initiatives in the future. Trading at 12x consensus earnings estimates for 2017, the institution is trading at a discount to peers.
Heartland Advisors value investing portfolio commentary utilities sector iconPowering up. Investors’ ongoing hunt for yield helped boost Utilities. The sector was a solid-performing group in the Index but as we’ve noted previously, valuations in the space are generally rich relative to the growth prospects for the average power company. In response, we continue to seek companies that have unique catalysts that should produce improved earnings. Exelon Corporation (EXC), we believe, is an example of this approach.
The company is a large multi-state utility with regulated as well as unregulated operations that sell power to other utilities. Improved returns on equity from recent acquisitions and improved efficiency should result in earnings per share growth in the high single digits for the regulated business line. Additionally, Exelon generates energy for its unregulated business through nuclear plants, which are at the lowest end of the production cost curve. 
Current valuation of 13x expected 2017 earnings per share (eps) put Exelon well below the 16x-22x eps average for similar regulated utilities. At current share prices, we believe the market is overlooking its above average growth potential and the additional value of their merchant business.

Portfolio Activity

Against a backdrop of continued political skirmishes in Washington and elevated multiples in the major indexes, we remain focused on finding companies that have a clear path forward to achieve improved sales growth and/or bottom-line revenue. For example, we recently took a stake in Berkshire Hathaway Inc. (BRK-B). The multi-business holding company is trading at a discount to its 15-year average price/earnings ratio despite having ample dry powder to deploy for accretive acquisitions. 
Our emphasis is on holding names with company-specific catalysts that can be achieved independent of the macro economic environment. 
We continue to trim winners as valuations warrant and redeploy gains into higher-quality names with robust balance sheets and enduring franchises.

Outlook and Positioning

The economic outlook is clouded but expansion could endure for several quarters to come. Stock performance during the past six months has made valuations of defensive and growth areas less compelling. Companies that have enjoyed strong runs over the past few months may face reduced upside until evidence of continuing business cycle strength emerges. 
In response, 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 wait for more clarity on the direction of the business climate, 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.
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Portfolio Management Team

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

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†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.

As of 6/30/2017, Amazon.com, Berkshire Hathaway Inc., Exelon Corporation, Wal-Mart Stores, Inc., and Wells Fargo & Company represented 0.0%, 4.4%, 3.0%, 3.2%, and 3.5% of the Opportunistic Value Equity Composite, respectively.

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

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.

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.

Additional Information for Indexes in Chart (calendar year returns %):

    1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD 2017*
Russell 3000® Growth Index   12.00 34.68 -1.31 41.66 5.22 3.69 2.20 36.57 21.88 28.74 35.02 33.83 -22.42 -19.63 -28.03 30.97 6.93 5.17 9.46 11.40 -38.44 37.01 17.64 2.18 15.22 34.24 12.44 5.09 7.39 13.69
Russell 3000® Value Index   23.63 24.22 -8.85 25.41 14.90 18.65 -1.95 37.03 21.59 34.83 13.50 6.65 8.04 -4.33 -15.18 31.14 16.94 6.85 22.34 -1.01 -36.25 19.76 16.23 -0.10 17.56 32.69 12.69 -4.13 18.40 4.32

*Not annualized as of 6/30/2017
Source: FactSet Research Systems Inc. and Russell®

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.