Heartland Opportunistic Value Equity Strategy 3Q18 Portfolio Manager Commentary

Executive Summary

  • On a year-to-date basis, the Strategy is outperforming its passive benchmark, the Russell 3000® Value Index, returning 7.98%† versus 4.17%.
  • The portfolio’s Consumer Discretionary and Industrials names boosted returns during the quarter, however, the Strategy modestly lagged its benchmark returning 4.96%† versus 5.39%.
  • Strong employment figures, robust manufacturing readings, and bullish consumer sentiment reignited a fear of missing out.
  • Instead of paying up for new names, we have opportunistically put money to work in existing holdings.
  • The economy continues its impressive run, yet energy markets and the yield curve highlight a lack of clarity long term.

Third Quarter Market Discussion

Strong employment figures, robust manufacturing readings, and bullish consumer sentiment reignited a fear of missing out on the part of investors. As a result, money poured into the market and the major equity indices notched new highs during the period. 
 
Asset flows underscored the renewed appetite for risk. By some industry estimates, the amount of cash invested in exchange traded funds (ETFs) that are focused on momentum has jumped 50% since the beginning of the year with one $70 billion ETF that tracks the 100 largest holdings in the growth-oriented NASDAQ growing by 8% alone. 
 
While equity investors focused on participating in near-term upside, economic prospects over the long haul remain unclear. The impact of recently enacted trade tariffs and higher interest rates have yet to be fully felt. On the other hand, tax cuts are expected to provide an additional lift for consumers and could have a spillover effect for the economy. As the chart below highlights, equity investors are more optimistic about the future while fixed income markets are flashing caution. As shown, the yield curve is flattening—which often points to lackluster economic prospects. Equity investors, however, are avoiding defensive areas of the market—as illustrated by the blue line. This divergence of views, we believe, highlights the value of a bottom-up investment approach that focuses on the strengths and weaknesses of a company regardless of economic backdrop.
 
Opposite Views?
Heartland Advisors Value Investing SHUT Index Chart
Source: © Copyright 2018 Ned Davis Research, Inc. and Standard & Poor’s. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
NDR SHUT Index is proprietary to Ned Davis Research, Inc. and is an acronym for Consumer Staples, Health Care, Utilities & Telecommunication Services representing defensive sectors. All indices are unmanaged. It is not possible to invest directly in an index. Bond Equivalent Yield (BEY).
Past performance does not guarantee future results.
 

Attribution Analysis

Security selection was mixed and the portfolio’s Consumer Discretionary and Industrials names boosted returns, however, the Strategy modestly lagged its benchmark, the Russell 3000® Value Index. Information Technology (IT) holdings were up double digits and were another bright spot. Commodities were weak during the period and our Materials holdings lagged. 
 
The price of crude softened and put pressure on shares of Energy companies. An overweight to and stock selection in the group detracted from performance. The portfolio’s Consumer Discretionary holdings were up and boosted absolute and relative performance.
 
Heartland Advisors Value Investing Industrials Sector IconCleared for takeoff. Continued economic strength helped lift shares of companies in the Industrial area and the group contained a top contributor. Shares of Spirit Airlines, Inc. (SAVE) were up after management reported solid earnings and issued better-than-expected guidance. 
 
During the past year, the discount airline faced pressure as larger carriers slashed prices and raised capacity in pursuit of market share in major hubs such as Chicago. During this period, we viewed excess capacity as a temporary challenge that would subside as fuel prices increased. The team also believed that Spirit’s low-cost advantage would allow it to weather heightened competition. In recent months, the influx of capacity has ebbed and airlines have benefited from a strong economy and confident consumer. Spirit has also improved its competitiveness by improving its on-time flight performance and offering amenities such as inflight Wi-Fi. 
 
The airline has a long runway in terms of expanding into additional markets and we think its mix of clients, which is light on business passengers, will help it hold up should the economy start to soften.
 
Heartland Advisors Value Investing Energy Sector IconPermian Pessimism. On the heels of a strong first half of 2018, oil prices faltered and the weakness spilled over into shares of Energy companies. Some of the hardest hit were names tied to the Permian Basin in West Texas where production has exceeded capacity to transport the oil out of the region. The portfolio’s holdings shared in the pain and the group contained a key detractor, Schlumberger Limited (SLB)
 
The company is a global energy equipment and services provider and a top-10 producer in the Permian region. While it is a dominant pressure pumper in the basin, revenues from its production unit accounted for just 20% of pretax income through the first six months of 2018.  We believe the recent pressure on shares is overdone and doesn’t accurately reflect Schlumberger’s dominant position in multiple segments beyond production. Additionally, the company’s global footprint should allow it to weather pricing disparities in various regions.
 
Recent opportunistic acquisitions and a significant share repurchase program should allow the company to generate earnings per share equal to the level enjoyed in 2014 even if revenues are a fraction of what they were at that time. Management’s prudent approach of buying assets at steep discounts and the strength of the Schlumberger franchise warrants further patience, in our view. 
 
Heartland Advisors Value Investing Consumer Discretionary Sector IconPerformance Parts. The portfolio’s Consumer Discretionary names were up sharply and boosted relative performance. The group has been a fertile area for the portfolio for much of the year and continues to produce some top contributors such as Advance Auto Parts, Inc. (AAP).
 
AAP is a dominant player in the fragmented auto parts industry. The company differentiates itself from peers through its client mix. While competitors focus on the do-it-yourself consumer, AAP has a significant advantage—more than double its closest peers—marketing to repair facilities. Unlike retail customers, who are generally price sensitive, commercial customers prioritize delivery speed and parts availability over cost savings. We believe this should help insulate the company from pricing pressures and volume erosion spurred by online retailers. 
 
We took a stake in the business when the outlook for the industry as a whole was weak due to a surge in new car sales. At that time, AAP was also working through challenges related to an earlier acquisition. Since then, management has grown sales, made significant strides toward its goal of reducing $1 billion in inventory, and increased operating margins. Shares of the company have appreciated on improved results. While we would not be surprised by a pause in performance, we believe management will continue to increase profitability in the quarters ahead.
 

Portfolio Activity

With the broader market trading near all-time highs, the team has been patient as we wait for valuations to come to us. Instead of paying up for new names, we have opportunistically put money to work in a handful of our existing holdings.
 
As the year wears on, we will continue to monitor our watch list of names and will act decisively as opportunities present themselves. 
 

Outlook and Positioning

Heartland Select Value Fund Portfolio Manager Commentary Quote
The economy continues its impressive run, yet energy markets and the yield curve highlight a lack of clarity for 2019 and beyond. In response, we remain committed to a philosophy and process that has helped us identify compelling opportunities regardless of sector or market cap that can succeed against a variety of economic backdrops. 
 
As always, we are focused on identifying businesses where margins have troughed as well as those facing broad negative sentiment or where Street earnings expectations have failed to keep pace with improving sales and earnings trends. Strong balance sheets should provide a cushion if the strength of the economy softens. 
 
Thank you for the opportunity to manage your capital.
Please wait while we gather your results.

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 16 years of industry experience, 9 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 18 years of industry experience, 14 at Heartland.

Composite Returns*

9/30/2018

Scroll over to view complete data

Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**10.499.379.7015.7514.547.984.96
Opportunistic Value Equity Composite (Net of Bundled Fees)8.397.257.5713.5012.346.414.46
Russell 3000® Value7.309.7610.6513.759.464.175.39

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

Email Sign Up

  • I am a financial professional or institutional investor
  • I am an individual investor

©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.

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

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 9/30/2018, Advance Auto Parts, Inc., Schlumberger Limited, and Spirit Airlines, Inc., represented 1.34%, 3.34%, and 1.88% 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 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.

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.

top