Heartland Advisors

Heartland Opportunistic Value Equity Strategy 2Q23 Portfolio Manager Commentary

Executive Summary

  • Investors shifted to a risk-on mode in the quarter, fueled by better-than-expected news on the inflation front and a growing hope that the Federal Reserve might be able to pull off a “soft landing.”
  • This sense of optimism belies further credit stress, leading to stricter lending standards, which draws attention to balance sheet strength. 
  • As the historically narrow market eventually broadens, we expect small- and mid-cap equities to benefit over a multi-year time horizon, giving an advantage to strategies that can move dynamically to opportunities as they arise.

Second Quarter Market Discussion

The second quarter was a shining example of how, even though investors have a lot to worry about, markets can rally unexpectedly. In short, consistent, and successful timing of the stock market should be reserved for fairy tales.

After a fearful start to the year, when the banking crisis dominated the headlines in March, investors seemed to shift back to a risk-on mode over the past three months. Sparked by inflation data that was cooler than expected and newfound hope that the Federal Reserve might be able to engineer a “soft landing,” the Russell 3000® Value Index jumped more than 8% in the three months ending June 30.

Yet the lion’s share of the market’s gains was driven by just seven mega-cap stocks: Apple, Alphabet, Tesla, Amazon, Microsoft, Meta and Nvidia. The Strategy owns one of these stocks, Alphabet. We own Alphabet because this equity offers a unique combination of attractive valuation and a business that seems to possess a deep economic moat with strong fundamentals. Others may possess one of these characteristics, but we will only own those that offer both.

While the Federal Reserve kept rates steady at its June Federal Open Market Committee (FOMC) meeting, the Central Bank is still leaning toward cooling the economy, according to the Federal Reserve’s most recent “dot plot.” That array reflects the expectations of each FOMC member, and the median dot (or forecast) for the Federal Reserve Funds rate climbed to 5.6% in June, up from 5.1%. This suggests the possibility of further monetary policy tightening later this year, which isn’t good news for richly priced and speculative investments that have led so far in 2023.

Another potential headwind for these stocks: the likelihood for further credit stress. Even if rates don’t rise further, many of the effects of higher borrowing costs are taking their toll. Consumer loan delinquencies are climbing, led by late payments on credit card and automobile loans, which have hit multi-year highs. While commercial real estate loans haven’t experienced broad-based credit stress yet, that could change as loans underwritten in a lower interest-rate environment come due and as the cost to hedge floating-rate debt increases. These warning signs, in addition to bank funding stress, have led to stricter lending standards at banks, which amounts to a form of tightening indirectly caused by Federal Reserve policy. This is why we believe balance sheet strength, while always important, will be rewarded in this tighter credit environment.

Though the market seems to be driven by a handful of mega caps, we remain confident that small- and mid-cap stocks will outperform over a multi-year time horizon. Why are we so confident? Part of it is rooted in history. Today’s market is narrower than it’s been in recent history, with fewer stocks on pace to beat the S&P 500® than even during the dotcom bubble (see chart below).

Percentage of S&P 500 Stocks that Outperformed the S&P 500

Source: Ned Davis Research, yearly data from 12/31/1973 to 12/31/2022 and partial year data from 1/1/2023 to 6/22/2023. This chart represents the percentage of S&P 500® Stocks that outperformed the S&P 500® over the calendar year.  All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Narrow breadth has been an indicator of structural weakness in the market. However, one area that stands to benefit from the fallout of sparse leadership is smaller stocks. Ned Davis Research examined past periods in which the market’s breadth narrowed — specifically, when fewer than 30% of the names in the S&P 500® were beating the benchmark. It found that in the 12 months following those instances, small-cap equities outperformed large every time.

Russell 2000/1000 Ratio Performance After Percent of S&P 500 Stocks Outperforming Index in Last Three Months Falls

Source: Ned Davis Research, daily data from 3/27/1980 to 5/31/2023. This chart represents the Russell 2000® to 1000® ratio performance after the percent of S&P 500® stocks outperforming index in last three months falls below 30%. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Beyond history, there’s also a fundamental reason why we believe the era of large-stock leadership, which began well before the start of the global pandemic, appears extended. Large-cap earnings have grown around 20% faster than small-company profits over the past five years, yet the former have outpaced the latter by around 45% over the same period. This means large caps have become more expensive and future return prospects are less attractive, all else equal.

As an all-cap Strategy that can go wherever we find the best risk/reward opportunities, we believe the Strategy is uniquely positioned to take advantage of this market once it returns to normalcy. And as patient and disciplined investors who lean on our 10 Principles of Value Investing,™ we are mindful not to overpay or overextend for those opportunities.

Attribution Analysis & Portfolio Activity

For the quarter, the Strategy was virtually on par with the Russell 3000® Value Index, posting gains of 3.86% versus 4.0% for the benchmark.

Stock selection was the primary driver of the Strategy’s performance led by outperformance in the Health Care, Utilities, Materials, and Real Estate sectors, partially offset by underperformance in Financials. We took advantage of the selloff in regional banks to add incremental exposure to the group, however, one of the Strategy’s bank holdings lagged peers in the second quarter. We remain confident in this bank’s financial strength and the margin of safety provided by its discounted valuation. 

While the Q2 rally was disproportionately driven by a few large, mostly tech-related, names within the S&P 500®, the situation was more nuanced within the Value universe. Large caps outperformed small but underperformed mid in the Russell 3000® Value Index. Though we are convinced that small- and mid-cap equities stand to benefit once the market broadens, we don’t target any specific cap size. We are bottom-up stock pickers who focus on financial, strategic, and leadership strength coupled with attractive valuations. 

Here are three examples of such companies:

Healthcare. Centene Corporation (CNC) is one of the largest managed health care insurance providers in the U.S. and the largest player in Medicaid. The stock has underperformed this year, as CNC faces reimbursement headwinds including a reduction in its 2024 Medicare Advantage premiums and higher healthcare utilization from the return of elective procedures. Investors also fear a potential loss of insured lives when Medicaid eligibility, which was expanded during the pandemic, gets redetermined in 2023-2024.

CNC’s historical results have lacked the consistency demonstrated by premier large managed care companies. However, since 2021, the company has steadily upgraded its leadership ranks from the CEO on down through the executive ranks and line-of-business leaders. CNC’s executive leadership is comprised of industry veterans with a demonstrated record of success. Their executive compensation is clearly aligned with shareholder value creation, and they recently bought large amounts of CNC stock personally in the open market, demonstrating confidence in their prospects. Self-help initiatives are well underway and include noncore divestitures, material expense streamlining, improved digital capabilities, improved provider contracting, and meaningful share repurchases. 

In our estimation, the market is too focused on near-term overhangs that will prove temporary and disregards the substantial value creation opportunities that lie ahead. CNC trades at just 10X 2023 earnings compared to peers valued at mid/upper teens P/E ratios. After a brief pause caused by the reimbursement headwinds in 2024, we expect CNC to resume its 12-15% EPS growth rate, comparable to leading industry operators. This should help close the valuation gap. 

Financials. Under the banner of ‘taking what the market gives us,’ we initiated a position in First American Financial (FAF), the second-largest title insurer in the country. While most people don’t think about title insurance when purchasing a home, policies indemnify homeowners and lenders against title defects that could result in significant loss arising from back taxes, liens, and other claims. Title coverage typically costs the homeowner less than 1% of the home purchase price. However, a defective title could result in losing the entire property.

Rising mortgage rates in 2022 weighed on First American shares. As the residential-mortgage 30-year fixed rate more than doubled from around 3% at the end of 2021 to more than 6% at the end of 2022, mortgage volumes quickly cratered. By late 2022, residential refinance volumes plunged by 85% and new purchase volumes fell more than 40%. As a result, FAF’s earnings expectations are down 40-45% relative to the cycle peak just over 18 months ago.

We believe the worst may be behind the company. Management has taken several steps to improve profitability, including exiting its unprofitable property and casualty operations and automating manual processes, which should boost margins. 

Meanwhile, these shares trade at just 12X earnings, based on forecasts for the next 12 months. While a P/E ratio of 12X is in line with the insurance industry, we do not believe the broader industry has the same cyclical earnings upside as First American. Historically, title insurers have traded at 15X or higher early in a cyclical recovery.

Industrials. In a fast-changing market with extreme volatility in individual stocks, we’re trying to be nimble. Simpson Manufacturing (SSD) is a good example of a great business that went from being fairly valued to undervalued to not compelling for new capital within a mere 18 months. The window to buy at a significant discount to intrinsic value lasted only around two quarters. We highlighted Simpson as a new idea in the fourth quarter 2022 letter, and we believe it exemplifies just how quickly the mood of the equity market can change. 

Simpson designs and manufactures connectors and fasteners that are used in new construction applications, particularly wooden structures. The company enjoys a dominant 75% market share of the domestic wood connectors industry driven by the company’s focus on engineering and a sales team that has ensured SSD products are specified in the design process. This advantageous market position allowed Simpson to exhibit pricing power even as raw material costs, including steel, have waned recently. As a result, management raised their outlook for fiscal year 2023 profit margins, and the stock has risen materially since our original purchase in October 2022. Certainly, the intrinsic value of Simpson does not go up and down by 40-60% each year, however, the stock fell by more than 40% in 2022 through October only to rise more than 60% over the past nine months.

Today, the shares are trading at 16X forward earnings. While we don’t believe Simpson is materially undervalued, the company could compound earnings and cash flow per share at a double-digit rate over time.


We have no control over what the market does on a quarter-by-quarter basis, but we have the ability to focus on companies with consistently generated cash flow that are conservatively financed and are led by capable management teams. In addition, we can patiently wait for these names to come to us with attractive valuations. 

While the constant shifting from risk-on to risk-off may be jarring, our Strategy is rooted in a few simple beliefs. Balance sheets matter. The price we pay for stocks matters. Despite the recent volatility in the markets, we believe that, eventually, the market will broaden out to the benefit of investors who have the flexibility to find the best opportunities from a bottoms-up standpoint across cap sizes.

We thank you for your continued trust and confidence.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Troy McGlone

Troy McGlone

Vice President and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

Vice President and Portfolio Manager

Composite Returns*

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Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.
*Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999. 
**Shown as supplemental information. 

The US Dollar is the currency used to express performance. Returns are presented net of advisory fees and net of bundled fees and include the reinvestment of all income. The returns net of bundled fees were calculated by subtracting the highest applicable sponsor portion of the separately managed wrap account fee from the net of advisor fees return.

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Past performance does not guarantee future results.

The Opportunistic Value Equity Strategy seeks to capture long-term capital appreciation by investing in companies with market capitalizations greater than $500 million. The Strategy’s flexible pursuit of value positions it as a core holding for investors.

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, Inc. at the address listed below.

As of 6/30/2023, Alphabet Inc. (Class A) (GOOGL), Centene Corporation (CNC), First American Financial Corporation (FAF), and Simpson Manufacturing Co. (SSD), represented 3.29%, 3.96%, 1.34%, and 1.09% of the Opportunistic Value Equity Composite’s net assets, respectively.  As of 6/30/2023, Amazon.com Inc (AMZN), Apple Computer Inc. (AAPL), Nvidia Corporation (NVDA), Meta Platforms Inc, Class A (META), Microsoft Corporation (MSFT), and Tesla (TSLA) were unowned by Heartland Advisors. 

The future performance of any specific investment or strategy (including the investments discussed above) should not be assumed to be profitable or equal to past results. The performance of the holdings discussed above may have been the result of unique market circumstances that are no longer relevant. The holdings identified above do not represent all of the securities purchased, sold or recommended for the Advisor’s clients.

Statements regarding securities are not recommendations to buy or sell. 

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

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.

The statements and opinions expressed in this article are those of the presenter(s). 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 are sourced from GICS®.The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global Market Intelligence (“S&P”).  Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose.  The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

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.

Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

In certain cases, dividends and earnings are reinvested.

There is no assurance that dividend-paying stocks will mitigate volatility.

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

Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indices. Russell® is a trademark of the Frank Russell Investment Group.

Data sourced from FactSet: Copyright 2023 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Bottom-up is an investment approach that de-emphasizes the significance of economic and market cycles. This approach focuses on the analysis of individual stocks and the investor focuses his or her attention on a specific company rather than on the industry in which that company operates or on the economy as a whole. 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. Federal Funds Rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. Federal Open Market Committee (FOMC) is the branch of the Federal Reserve Board that determines the direction of monetary policy. The FOMC is composed of the board of governors, which has seven members, and five reserve bank presidents. 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. Intrinsic Value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Margin of Safety is a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. Price/Earnings Ratio of a stock is calculated by dividing the current price of the stock by its trailing or its forward 12 months’ earnings per share. Risk on/Risk off Theory is an investment setting in which price behavior responds to, and is driven by, changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns. During periods when risk is perceived as low, risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived as high, investors have the tendency to gravitate toward lower-risk investments. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indices. Russell® is a trademark of the Russell Investment Group. Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000® represents approximately 92% of the U.S. market. Russell 2000® Index includes the 2000 firms from the Russell 3000® Index with the smallest market capitalizations. All indices are unmanaged. It is not possible to invest directly in an index. Russell 3000® Value Index measures the performance of those Russell 3000® Index companies with lower price/book ratios and lower forecasted growth characteristics. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index. Volatility is a statistical measure of the dispersion of returns for a given security or market index which can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security. 10 Principles of Value Investing™ consist of the following criteria for selecting securities: (1) catalyst for recognition; (2) low price in relation to earnings; (3) low price in relation to cash flow; (4) low price in relation to book value; (5) financial soundness; (6) positive earnings dynamics; (7) sound business strategy; (8) capable management and insider ownership; (9) value of company; and (10) positive technical analysis.