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Heartland Mid Cap Value Fund Reaches Three-Year Milestone

Q&A with co-portfolio manager Colin McWey
  • <strong>Heartland Advisors</strong>
  • <strong>Colin McWey, CFA</strong>

"The prices of deep-value firms were so dramatically beaten down in 2015-16 that we tilted the portfolio to that bucket and benefited as the market shifted late in 2016." - Colin McWey

    MILWAUKEE, WI, October 31, 2017 /24-7PressRelease/ -- The Heartland Mid Cap Value Fund (NASDAQ: HRMDX), Heartland Advisors' mutual fund focused on mid-sized companies, today marked its three-year anniversary. With market volatility near historic-low levels--and the Russell Midcap Value Index climbing steadily higher--market dynamics seem to suggest little has changed over the course of 2017. In the following Q&A, Colin McWey, CFA, digs below the surface, showing things have changed, especially regarding catalysts for further potential share-price appreciation.

McWey co-manages both the Fund and the Firm's Mid Cap Value Strategy, which Heartland has offered since 1996. McWey took leadership of the separate account strategy in January 2013 and has applied the same investment process to managing the Fund since its launch three years ago.

Q: What's changed for mid-caps versus this time last year?

In the latter part of 2016, a shift in sentiment arrived after years of dominance by the "growthier" parts of the market. Finally those areas took a backseat to cyclical sectors as investors recalibrated following the U.S. presidential election.

At that time, our portfolio was tilted toward what we call "deep value." At a company-specific level, our scoring process, using our 10 Principles of Value Investing, led us to beaten-up companies trading at prices we saw as irrationally low. This included cyclical stocks in areas such as Energy, Industrials, and Materials. These companies had experienced true bear-market conditions, as commodities swooned and capital expenditures troughed.

This late-2016 swing back toward value was a boon to value stocks, including those that had more recently experienced a kind of stealth bear market.

However, the pendulum has swung back toward growth in 2017, once again reestablishing the general pattern of this bull market with growth dominating value. As dyed-in-the-wool value managers, our portfolio remains unapologetically tilted toward value.

Given that growth has outperformed value by well over 10%* so far in 2017, our approach is out of favor. Environments like this put our stock picking to the test because there are no tailwinds behind our pure-value strategy. But at some point, we believe the market will shift again--as it always does--and the long-run benefits of paying close attention to the prices we pay for companies will once again come to the fore.

Q: What sets apart the "deep value" stocks you mentioned from other value-oriented investments?

In addition to the "traditional value" bucket of solid companies experiencing some kind of temporary overhang, we identify investment candidates in the "deep value" bucket. These companies have less-distinguished operations and competitive positioning. Our interest in deep value swells when we see situations in which price relationships throughout the marketplace are way out of whack. Deep-value companies have the potential to substantially rise in value as those price relationships normalize. Causes of that mean-reversion could be stock-specific catalysts, a removal of key company overhangs, broad-based economic improvements, or a change of sentiment that fuels investor skepticism of high-flying growth companies.

As I mentioned, the prices of deep-value firms were so dramatically beaten down in 2015-16 that we tilted the portfolio to that bucket and benefited as the market shifted late in 2016. Now, our portfolio is more balanced between traditional value and deep value.

Q: How has your outlook on catalysts changed over the past year?

When valuation discrepancies were at their most extreme, we favored deep-value names that could benefit from their own improvement efforts, along with rising capital expenditures (capex) and customer demand off cyclically low levels. This was a highly contrarian view--as evidenced by the beaten-down prices of companies we selected in areas such as Machinery, Banks, Energy, and Materials. These groups were among those that snapped back the most as optimism rose in the latter part of 2016.

Now, broad-based growth is already evident in the economy. We don't expect a rise in capex spending to be a widespread future catalyst for recognition as we did a year or two ago. Instead, the catalysts we see now tend to be more individual-company driven. Not surprisingly, our investment selections within Industrials are now more broadly diversified across a variety of services and manufacturing players. Our portfolio posture a year ago--positioned for a broad snap-back--and now--focused on more company-by-company catalysts--are a direct outcome of our analysis of individual stocks using our 10 Principles of Value Investing(TM).

Q: As you reflect on the Fund's first three years, what stands out to you about mid-cap investment opportunities in general?

My practical experience lines up with academic literature that shows how mid-sized companies can offer some of the best aspects of both smaller and larger firms. Specifically, they offer the potential for higher long-term returns than large-cap stocks and lower volatility than small-cap stocks.

Our research on individual companies bears out some intuitive reasons for this "sweet spot" in the capitalization spectrum. We see mid-cap companies that, like smaller firms, can grow their earnings faster--sometimes much faster--than their larger peers. But on the other hand, mid-sized firms often have positive attributes of large companies, such as more stable profits, dominant market share, better diversification of risk, steadier cash flows over time, and a lower cost of capital in debt and equity markets.

It's that combination of traits we look for: companies that can grow like small-cap companies while providing some of the defensible characteristics of large-caps.

About Heartland
Established in 1983, Heartland Advisors, Inc. is an independently owned equity value investment manager based in Milwaukee, Wisconsin. The Heartland family of value-driven, actively managed portfolios includes distinct U.S. and international strategies, offered through five mutual funds and four separately managed accounts. Learn more at heartlandadvisors.com.

*Russell 3000 Growth Index(R) vs. Russell 3000 Value Index(R), as of 10/27/2017
Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell(R) is a trademark of the Frank Russell Investment Group.

The inception date for the Mid Cap Value Fund is 10/31/2014 for the investor and institutional class.

Past performance does not guarantee future results.

An investor should consider the Fund's investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information can be found in the Fund's prospectus. To obtain a prospectus, please call 800-432-7856 or visit heartlandadvisors.com. Please read the prospectus carefully before investing.

The Mid Cap Value Fund invests in a smaller number of stocks (generally 30 to 60) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund's returns. The Fund also invests in mid-sized companies on a value basis. Mid-sized securities generally are more volatile and less liquid than those of larger companies. There can be no assurance that the Fund will grow to or maintain an economically viable size, in which case the Board of Directors may determine to liquidate the Fund. There is no assurance that dividend-paying stocks will mitigate volatility. Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

The statements and opinions expressed in this article are those of the author. Any discussion of investments and investment strategies represents the presenter's 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. Any forecasts may not prove to be true. There is no guarantee that a particular investment strategy will be successful.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap(R), small-cap by the Russell 2000(R), mid-cap by the Russell Midcap(R), large-cap by the Russell Top 200(R).

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.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy emphasizes capital appreciation and typically carries a higher risk of loss and potential reward than a value investing strategy; a value investing strategy emphasizes investments in companies believed to be undervalued.

Capital expenditure are funds used by a company to acquire or upgrade physical assets, such as property, industrial buildings, or equipment.

Diversification does not eliminate the risk of experiencing investment losses.

CFA(R) is a registered trademark owned by the CFA Institute.

The Heartland Funds are distributed by, and Colin McWey is a registered representative of, ALPS Distributors, Inc. 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.

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