Heartland Opportunistic Value Equity Strategy 4Q16 Portfolio Manager Commentary

Executive Summary

  • Security selection was strong in a majority of sectors and helped the Strategy outpace its benchmark, the Russell 3000® Value Index, returning 10.08%† versus 7.24%.
  • Market strength has made valuations among cyclical names less compelling.
  • We continue to comb through all industries looking for where we believe risk is mispriced.

Fourth Quarter Market Discussion

A soft start to the quarter for the major indexes turned into a sprint to new highs following the presidential election. Investors viewed the outcome as a catalyst for growth and, as shown, economically sensitive sectors benefited the most.

A Post Election Liftoff

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary Sector Returns Chart

Source: FactSet Research Systems, Inc., Heartland Advisors, Inc., and Russell®
Holdings data as of 10/3/2016 to 11/7/2016 and 11/9/2016 to 12/30/2016
Past performance does not guarantee future results.

Increasing confidence that rates were heading higher led to selling pressure for so-called “bond proxies” but boosted beneficiaries of Fed tightening. Economic optimism also took a toll on some defensive areas. Smaller companies led on the upside, continuing a trend begun last quarter.

Attribution Analysis

Security selection was positive in a majority of sectors and helped the strategy outpace its benchmark, the Russell 3000® Value Index. Financial holdings and Consumer Staples were key sources of strength followed by names in Energy. Health Care holdings were up modestly in absolute terms but strong on a relative basis. Stock selection in Materials hurt results.

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary energy iconRe-energized. Baker Hughes Incorporated (BHI) was a top contributor after announcing it was entering a merger agreement with General Electric Company (GE). The company is a top-five oil services business and should become the second-largest player once the deal is completed.

We initiated a position in the stock in spring. Valuations at the time were under pressure after the Department of Justice blocked an acquisition of the company by a top competitor. We believed the decision would lead to another bidder emerging and thought the depressed multiples were unwarranted.

Recent performance has closed the valuation gap between BHI and its peers, and we have been trimming the position. Prospects for the company remain attractive, and we expect the merger will produce greater cost savings than are being projected.

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary financials iconFinancial fitness. The portfolio’s Financial names performed well. Wells Fargo & Company (WFC) was a key contributor as banks were up on expectations that net interest margins would rise due to higher interest rates. Additionally, the markets anticipate regulations for the industry will become less restrictive under a Trump administration. We have long viewed Wells Fargo as a well-run, broadly diversified operator with a strong brand. We initiated a position in the stock after the company came under scrutiny for some of its sales practices. The news is a serious matter; however, investor reaction created an opportunity to buy a market leading franchise at a significant discount.

The stock has posted double-digit gains since our initial purchase but still trades at 2.0x tangible book value versus a 20-year median of more than 5x. As the financial overhang from the sales issues fades in the quarters to come, the company should once again command a premium to peers.

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary industrials iconHitting the ground running. Kennametal Inc. (KMT), a name we highlighted last quarter as a new addition to the portfolio, has begun to produce results. The company is the third-largest maker of tools used in the metal working industry. Shares were up after it provided better than expected 2017 guidance and presented forecasts of higher than expected earnings power for several years. The stock also benefited from improving industrial demand following several quarters of contraction.

We remain confident in the new CEO’s plan to reduce costs and reorganize its sales approach. Kennametal is trading at 12-13x our estimates of earnings power versus a historic average of 14x, which makes for a compelling risk/reward profile.

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary IT iconTechnology glitch. The portfolio’s Information Technology (IT) holdings contributed modestly on an absolute and relative basis but contained a detractor.

CA, Inc. (CA) was down after reporting solid earnings but softer-than-expected sales in its enterprise solutions business, which were tied to mainframe renewals. Shares also faced pressure as investors turned away from slow-growth, cash-producing IT names in favor of economically sensitive areas.

Given CA’s free cash flow to enterprise value yield of almost 8% and a 3.3% dividend yield, we believe investors are overlooking the company’s growth in software as a service (SAAS) sales that are independent of mainframe renewals. The traction in the SAAS business should lead to top line and earnings growth in the coming quarters.

Portfolio Activity

The rapid rise of economically sensitive sectors has made valuations among cyclical names less compelling. Our response has been to pare exposure in some areas or rotate to less volatile names within a sector. For example, following the strong run among financials, we’ve reduced our commitment to the group modestly. We’ve also harvested gains from smaller banks and are finding opportunities in larger institutions that are less dependent on net interest margins.

Outlook and Positioning

The markets have reached a period of transition. The economic outlook is brighter than it was at the start of 2016, yet strong stock performance has made valuations less compelling. Similarly, defensive areas that were priced at a premium during the first half of the year have come down in price but have yet to reach a compelling level.

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 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

The beginning of 2017 will mark the final step in a multi-year transition as Portfolio Manager and Heartland veteran David Fondrie retires effective April 30. Dave began discussing his decision with leadership five years ago and we have been working diligently since then to make the move seamless.

Following Dave’s retirement, the Opportunistic Value Strategy will continue to be managed by Will Nasgovitz and Colin McWey. Will has served as a Portfolio Manager of the Strategy since May 2006 and Colin since February 2015.

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 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*

Scroll over to view complete data

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.

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.

Dividend paying stocks cannot eliminate the risk of investment losses. 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.

As of 12/31/2016, Baker Hughes Incorporated, General Electric Company, Wells Fargo & Company, Kennametal Inc., and CA, Inc. represented 3.1%, 0.0%, 2.6%, 2.5%, and 2.6% 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®.

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.