Heartland Advisors

Heartland Opportunistic Value Equity Strategy 1Q25 Portfolio Manager Commentary

Executive Summary

  • Speculation that drove the market last year abruptly ended and gave way to fear in the first quarter, resulting in a challenging quarter for broad-based equity indices.
  • As more businesses are being priced for a meaningful economic slowdown, we are finding opportunities to increase our exposure to parts of the market that have been adversely affected by the shifting narrative. 
  • Though large-cap stocks outperformed amid a “flight to safety,” we have been leaning into small-stock weakness, focusing on names with strong balance sheets and high returns on invested capital.

First Quarter Market Discussion

Warren Buffett famously said that market downturns don’t bother him because “it is an opportunity to increase our ownership of great companies with great management at good prices.” That is how we’re approaching this market.

The speculation that drove stocks last year abruptly ended amid growing concerns of an economic slowdown spurred, in part, by uncertainties surrounding tariffs and fiscal policy. While we are not economists and don’t approach our jobs from a macro perspective, we observe a widening range of companies highlight softening consumer and business confidence resulting from tariff uncertainty. It’s reasonable to conclude that the longer this uncertainty persists, the more damage a potential pullback in consumer spending and business investment could do to the economy. 

This concern pushed stock prices lower in the first three months of the year, with the S&P 500 Index falling briefly into correction territory (defined as a drop of 10% or more) between Feb. 19 and March 13. The S&P 500 finished the quarter down 4.3%. As is often the case in a fear-driven market, small stocks were hit harder, with the Russell 2000® Index slipping around 9.5%.

At the beginning of the year, we argued that the market was overlooking potential downside risks, as there are no guarantees the new administration’s efforts to boost GDP growth would succeed. Today, the opposite may be true. Investors are so consumed with the risk of a global trade war and stagflation; they seem to be overlooking potential opportunities that market volatility is exposing. The Investors Intelligence Sentiment Index, for instance, indicates a rapid shift in investor sentiment, with bullishness dropping swiftly from exuberance to pessimism on par with the 2008-09 global financial crisis, the 2015 industrial recession, the 2020 COVID-19 shutdowns, and the 2022 interest rate spike (see the chart below).  

Consumer Confidence Index v. Real GDP Growth

Source: Bloomberg. Daily data 3/30/2005 to 3/28/2025. This chart represents the recession periods comparing the Bloomberg Global High Yield and the Investors Intelligence Sentiment Data Percentage. The Bloomberg Global High Yield Index is a multi-currency flagship measure of the global high yield debt market. The index represents the union of the US High Yield, the Pan-European High Yield, and Emerging Markets (EM) Hard Currency High Yield Indices. The Investors Intelligence Index is a common and widely accepted means of ascertaining the balance of power between the bulls and bears. In actuality, the index may refer to one of several possible sentiment indicators, including an advisor sentiment review and an insider activity review. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

As more businesses are being priced for a meaningful economic slowdown, we are finding opportunities to increase our exposure to parts of the market that have been adversely affected by the shifting narrative. Guided by our 10 Principles of Value Investing™, we continue to focus on attractively priced, well-managed businesses that can grow intrinsic value throughout market cycles, while avoiding areas of the market at risk of permanent capital destruction. For instance, high-yield credit spreads, a measure of excess yield required by investors to own low quality debt, have only just begun to widen after hitting a cyclical low in late February (see the chart above) thus we still see plenty of downside in the equity of highly leveraged businesses.

Attribution Analysis

Our Strategy gained 0.90% (net of bundled fees) in the first quarter, trailing the performance of the Russell 3000® Value Index, which was up 1.64%. Stock selection was mixed in the quarter, with a positive selection effect in 5 of 11 sectors, led by Utilities and Information Technology. 

There was a flight to safety at the start of the year, as the best-performing sectors in the Russell 3000® Value Index were defensive areas such as Energy and Utilities while cyclicals generally lagged. However, we outperformed the benchmark in several economically sensitive areas of the market including Information Technology, Financials, and Consumer Discretionary.

Large stocks in the benchmark outperformed by more than 800 basis points, another sign of risk aversion. This proved to be a headwind for our Strategy during the quarter, as large caps comprise just 28% of our exposure, with small and midcaps representing a combined 72%. We are confident, however, that the smaller companies we own are concentrated in undervalued businesses with strong long-term prospects.

Portfolio Activity

We construct our portfolio based on individual company fundamentals rather than sectors or market-cap preference. That said, we recognize that large caps typically outperform during periods of heightened volatility. With small-cap stocks generally pricing in slower economic growth more quickly, we increased our small-cap weighting by 400 basis points to 34%. Consistent with our investment philosophy, we prioritize companies with strong balance sheets and high returns on invested capital to mitigate downside risks.

Industrials. During the quarter, we initiated a new position in Donaldson Company, Inc. (DCI), a leading manufacturer of industrial filtration systems. Filtration is a “razor & razorblade” business model, with margins significantly lower on first-fit original equipment and higher on the annuity-like revenue stream from aftermarket sales. Thanks to Donaldson’s long history of operating in niche markets, its business skews around 65% aftermarket and 35% first fit, providing a more stable revenue profile than traditional Industrial machinery suppliers.

While DCI has historically traded at a premium to its Industrial machinery peers, because of its stable and more profitable revenues streams, the stock recently faced multiple compression due to margin headwinds created by the company’s investments in the life science industry. The life science portion of the business accounts for less than 10% of revenues yet Donaldson reported an operating loss in the segment due to new product development spend that is immediately expensed through the income statement. 

We believe the investment headwinds are fully priced into the stock and expect life science filtration sales to be accretive to both revenue growth and margins in the longer term. Over the next two to three years, we expect the segment’s margins to approach the corporate average, which would translate to a 10-15% lift in total earnings power for the company.  

Despite softness in the ISM Manufacturing Purchasing Managers Index since late 2022, DCI has historically outperformed when Industrial activity weakens due to the consumable nature of its products. Over the past two decades, the company has traded at a median 15% premium to the Industrial sector. Yet today, the stock is at nearly a 15% discount, based on its EV/EBITDA over the next 12 months. 

Information Technology. Teledyne Technologies, Inc. (TDY) has a well-managed, balanced portfolio of sensing and decision-support technologies across commercial and industrial end markets, including multiple secular growth areas spanning advanced machine vision, precision instrumentation, space and unmanned vehicles. The company’s economically sensitive customer exposure is somewhat buffered by stable markets like pollution control, water, oceanography and climate monitoring. TDY’s core markets are characterized by high barriers to entry and include niche specialized products and services unlikely to be commoditized.

In a challenging quarter for large tech stocks, Teledyne shares hit an all-time high at the start of the year, after beating consensus earnings estimates and continuing to expand profit margins despite getting little help from its challenged short-cycle end markets (where TDY has some of its highest-margin products). This helped investors imagine what earnings power could be if short-cycle markets recover.

Teledyne continues to execute secular growth opportunities while demonstrating that its commercial businesses are more economically resilient than many tech-industrial peers. Despite this strong execution and the stock’s recent performance, the shares still trade at the lower end of the relative valuation premium range that the stock has carried over the past decade. As we witness a “reality check” spreading across a number of companies that were trading at what we consider undeserved valuations, we think TDY’s prospects for strong relative performance remain bright.

Industrials. This was a challenging quarter for JB Hunt Transportation Services, Inc. (JBHT), a diversified transportation company with a focus on intermodal shipping. Customers hire Hunt to move freight in a more efficient manner than substitutes. The company owns the largest fleet of 53-foot shipping containers, which allows three ocean-freight containers to be consolidated into two Hunt containers that are moved by rail (via third party partners) and by company-owned trucks that transport containers to their final destination.  Rail is the most efficient method of freight transportation, and Hunt is a key enabler of transferring semi-trailer miles onto railroads.

While the company’s fourth-quarter earnings came in slightly better than consensus estimates, management provided an uncharacteristic preview of challenging earnings expected in early 2025. Intermodal pricing is typically struck annually, and contracts agreed upon when the substituted trucking industry was operating near trough demand will carry into 2025 and keep margins depressed.  While recent intermodal volumes have been strong, we believe this is largely due to inventory buildup in anticipation of tariffs, raising the likelihood of weaker demand later in 2025. 

The intermodal industry appears oversupplied today; however, Hunt’s largest rail partner, Burlington Northern Santa Fe (BNSF), is constructing a major terminal expansion California.  BNSF plans to have this facility complete over the next two to three years resulting in new demand that will absorb Hunt’s recent fleet growth. Despite near-term headwinds, the stock trades at around 9.6X consensus EV/EBITDA over the next 12 months, which represents a 15-year low 30% discount to the Industrial sector and is in line with the company’s long-term valuation despite a greater than 30% decline in earnings expectations since 2022. In other words, we do not expect significant multiple compression as earnings recover.  JBHT operates in a cyclical industry, yet the company has grown per-share earnings at a mid-teens annual growth rate over multiple decades.

Outlook

At the beginning of the year, when investor confidence was booming and economic growth expectations were accelerating, we highlighted that sentiment is often a contrarian indicator. At the end of the first quarter, after bullishness morphed into severe bearishness, our perspective remains unchanged: selective opportunities are emerging for disciplined, patient investors. While near-term fundamentals remain challenging for many cyclical sectors, markets are generally forward-looking. We agree with Buffett that volatile times create opportunities to increase our stake in great companies at good prices. By adhering to our 10 Principles of Value Investing™, we remain committed to identifying strong management teams, durable business models, and robust balance sheets that can drive long-term intrinsic value growth.

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*

3/31/2025

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**9.928.7717.369.105.871.251.25
Opportunistic Value Equity Composite (Net of Bundled Fees)7.926.9115.637.604.410.900.90
Russell 3000® Value7.618.6316.136.286.661.641.64

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 3/31/2025 Donaldson Company, Inc. (DCI), JB Hunt Transport Services, Inc. (JBHT), and Teledyne Technologies, Inc. (TDY), represented 1.05%, 2.70%, and 2.27% of the Opportunistic Value Equity 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 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 2025 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. Buyback is the repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Chicago Board Options Exchange Market Volatility Index (CBOE VIX) is a mathematical measure of how much the market thinks the S&P 500 Index option will fluctuate over the next 12 months, based upon an analysis of the difference between current S&P 500 put and call option prices. 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. Enterprise Value/Sales Ratio is a financial indicator used to determine the value of a company including debt. It is equal to a company’s Enterprise Value divided by its annual sales. Federal Funds Rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. 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. IPO is Initial Public Offering 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. 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. NFIB Small Business Optimism Index is a small business optimism index compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members. The index is a composite of ten seasonally adjusted components based on questions on the following: plans to increase employment, plans to make capital outlays, plans to increase inventories, expect economy to improve, expect real sales higher, current inventory, current job opening, expected credit conditions, now a good time to expand, and earnings trend. Real Estate Investment Trust (REIT) is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. 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 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 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. Turnover is the lesser of Total Market Value of Purchases or Sales/Average Monthly Market Values. Unemployment Rate measures the number of people actively looking for a job as a percentage of the labor force. 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.

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