Heartland Advisors

Heartland Small Cap Value Plus Strategy 1Q23 Portfolio Manager Commentary

Executive Summary

  • To the growing list of economic challenges that included rising rates and inflation, you can now throw in a banking crisis, which emerged in the first quarter. 
  • On a positive note, troubles in the banking sector have refocused the markets attention on balance sheet strength, which bodes well for long-term investors.
  • In a world where there don’t seem to be any economic catalysts to rely on, we believe it makes sense to focus on companies with compelling self-help strategies. 

First Quarter Market Discussion

For months, as the Federal Reserve has been raising rates in an effort to slow inflation, we’ve been waiting for something to break. That’s because we have learned that whenever the Federal Reserve pushes short-term rates above 2-Year Treasury yields—as is the case today—something bad generally happens in the economy.

Well, in the first quarter, that turned out to be the banking crisis. After the sudden collapse of Silicon Valley Bank, Signature Bank, and Silvergate Capital in March, along with worrisome headlines swirling around Credit Suisse and First Republic, investors were left scrambling to figure out which institutions needed to raise capital quickly to shore up their balance sheets.

As disciplined value investors, we view this as a positive development. Heading into the quarter, there had been indications that fundamental factors such as valuations and earnings were finally being taken seriously again. However, investors hadn’t completely bought in, as they continued to overlook balance sheets in general and leverage specifically. That’s likely to change now, thanks to troubles in the banking sector which in turn have driven up credit spreads. 

To be sure, in past crises, the Federal Reserve has raced to the market’s rescue by printing money, which in turn has resuscitated speculation. Complicating matters for the Federal Reserve this time, however, is that inflation remains a front-burner concern, as is the growing federal budget deficit, sovereign debt, and corporate and consumer leverage.

In this environment, balance sheet strength is paramount, especially in the small-cap space as the screws are tightening from a funding perspective. Credit stress typically shows up as the Federal Reserve raises rates, as can be seen by the performance of leveraged loans relative to the Federal Funds rate in the chart below.   

Heartland Advisors Value Investing Trailing Earnings vs Forward Earnings

Source: Bloomberg L.P., Standard & Poor’s, monthly data from 1/31/2010 to 3/31/2023. The chart represents Federal Funds Rate Index compared to Leveraged Loan Pricing. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

At the start of the year, it was challenging enough for smaller companies to raise capital in the fixed income and equity markets. Now the banking market is starting to close. This shines a spotlight on financially sound, well-run businesses with sound strategies, which are traits embedded in our 10 Principles of Value Investing™.

Indeed, in this environment, the types of companies we have always focused on — well-managed companies with little or no leverage, strong balance sheets and consistent free cash flow generation to self-finance their organic growth and raise their dividends over time  — stand to benefit going forward.

Attribution Analysis & Portfolio Activity

While we believe the market is moving in our direction, we haven’t seen a big benefit from it just yet. In the quarter, the portfolio outperformed the Russell 2000® Value Index, thanks to relative outperformance in Industrials and Health Care.

In general, we are very comfortable with how the portfolio has been positioned, but we did make some tweaks around the edges later in the quarter to take advantage of what the market was giving. We were particularly focused on opportunities in companies that have compelling self-help strategies. This is because at a time when there aren’t many economic or market catalysts you can rely on, self-help advantages stand out.

A good example is Avanos Medical (AVNS), a medical device company focused on products related to pain management, chronic care, and digestive and respiratory health. 

This is a story of addition by subtraction. Avanos, which we added to in the quarter, announced plans to wind down around $35 million of its slowest-growing and least profitable parts of the business and take a restructuring charge. This portfolio optimization could amount to roughly $55 million in gross cost savings. The company’s self-help moves are also likely to boost its EBITDA margin to 22%, up from 16-17% in 2022. 

Meanwhile, AVNS has a very strong balance sheet, sporting a Net Debt/EBITDA ratio of less than 1. And the stock is quite cheap, trading at approximately 9 times EV/EBITDA based on ’24 estimates.


The first quarter proved to be a Tale of Two Markets. Up until the start of March, investors were caught up in a speculative junk rally that all but ignored quality stocks and dividend payers. Then with the banking crisis, the script was flipped very quickly, and financially healthy businesses with strong balance sheets and are back in vogue.

At Heartland, we think those traits, which are found in our 10 Principles of Value Investing™, are always in fashion. Make no mistake: Our portfolio won’t be immune to the effects of a banking crisis and other economic headwinds. But we believe our companies will be less affected than the broader market on the downside. 

As Warren Buffett famously said: “Only when the tide goes out do you discover who’s been swimming naked." We intend to be the ones with swimming suits on ready to uncover real bargains. 

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Bradford A. Evans

Bradford A. Evans

Senior Vice President and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Andrew Fleming

Andrew J. Fleming

Director of Research, Vice President, and Portfolio Manager

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Small Cap Value Plus Composite (Net of Advisory Fees)**7.647.438.9621.01-0.360.440.44
Small Cap Value Plus Composite (Net of Bundled Fees)6.816.908.4320.41-0.850.310.31
Russell 2000® Value6.557.224.5521.01-12.96-0.66-0.66

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 11/30/2007. 
**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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©2023 Heartland Advisors | 790 N. Water Street, Suite 1200, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

Past performance does not guarantee future results.

The Small Cap Value Plus Strategy primarily invests in companies that have a market capitalization consistent with the capitalization range of the Russell 2000 Value Index, with a majority of its assets invested in companies that pay dividends. The Strategy intends to capture the long-term appreciation of small-caps, while minimizing the volatility of returns inherent in the small-cap market.

The Small Cap Value Plus Strategy invests in small companies selected on a value basis. Such securities generally are more volatile and less liquid than those of larger companies.

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 3/31/2023, Avanos Medical (AVNS) represented 3.03% of the Small Cap Value Plus Composite’s net assets, respectively.  

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 holdings are subject to risk.

In certain cases, dividends and earnings are reinvested.

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.

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.

Defensive stocks include Utilities and Consumer Staples. These companies usually don’t suffer as much in a market downturn as they relate to basic needs. 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. Leverage is the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Russell 2000® Value Index measures the performance of those Russell 2000® companies with lower price/book ratios and lower forecasted growth characteristics. All indices are unmanaged. It is not possible to invest directly in an index. Sell-Side Analyst is an individual who typically works for a brokerage firm and evaluates companies for future earnings growth and other investment criteria. They sometimes place recommendations on stocks or other securities, typically phrased as "buy", "sell", or "hold." Yield is the income return on an investment. Yield Curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. In a positive-sloping yield curve, short-term debt instruments have a lower yield than long-term debt instruments of the same credit quality. A negative, or inverted, yield curve occurs when short-term debt instruments have a higher yield than long-term debt instruments of the same credit quality. 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.