Fourth Quarter Market Discussion
For value investors, there comes a point in every cycle when it becomes exceedingly difficult to be a contrarian, requiring every ounce of discipline to stay true to one’s principles. That’s where we found ourselves in the fourth quarter.
As other investors seemed to buy into the notion that they could have their cake (moderating inflation) and eat it too (ongoing growth), the wall of worry that every market must climb seemed to evaporate overnight. After falling in the first four weeks of the quarter, small-, mid-, and large-cap stocks surged starting in late October, led by speculative, highly leveraged companies that stand to benefit in the early stages of a new cycle.
Since the end of October, the broad market delivered more than a year’s worth of gains in just nine weeks, with the all-cap Russell 3000® Index up 15.1% and the Russell 2000® Index of small stocks surging 22.4%.
Never mind that Federal Reserve policy generally acts with a lag, which means bad news may yet emerge in the coming months. Forget, for the moment, that there are two major ground wars being fought with the potential to impact oil prices. And let’s also ignore the collapse of the personal savings rate and record credit card debt, which hints at further challenges for the consumer economy.
All of these concerns notwithstanding, the consensus view seems to be that the Federal Reserve will be able to stick a “soft landing” and slash interest rates aggressively this year. With the futures market pricing in six potential rate cuts in 2024, even the fixed income market is embracing this narrative, with yields on 10-Year Treasuries down from close to 5% in late October to approximately 3.9% at the end of the quarter, further emboldening risk-taking.
As demoralizing as this environment is for fundamentally driven, defensive-minded investors like us, it is risky—and late in the game—to jump on the bandwagon. Instead, we believe this is the time to look for opportunities that fit our process while sticking to our guns and making good decisions based on Heartland’s time-tested principles.
Attribution Analysis
In the fourth quarter, the Value Plus Strategy returned approximately 7%, trailing the Russell 2000® Index, which returned 15.3%. The underperformance was attributable to our defensive positioning, stock selection (particularly in Energy), and underweight exposure to early cycle parts of the market such as Financials, which were the benchmark’s best-performing sector.
The Value Plus portfolio is constructed with low-volatility, low-debt stocks that can thrive in good times and bad. Starting in late October, though, high-beta, highly leveraged, early-cycle companies came into favor, especially as investors grew convinced that a soft landing was at hand. Historically, in periods when the portfolio has been underweight to certain sectors that detracted from performance, certain overweights have compensated. In the fourth quarter, however, our allocation decisions weren’t of much assistance.
The fact is that the portfolio has been too defensively positioned given the current euphoria in the markets. But we also believe that this is a phase in the cycle where the market is pleading with contrarians to capitulate to current perspectives.
We have made some modest pivots, including aligning sector allocations more closely to benchmark weightings where possible. In a market rewarding high-beta stocks, where the portfolio has little exposure, we are also looking for beta—but only when it overlaps with our 10 Principles of Value Investing™, which require us to look for well-managed, financially strong businesses with sound balance sheets trading at attractive prices to help create a margin of safety. Our process can coincide with some higher-octane names, but we remain extremely disciplined when it comes to key considerations such as leverage, financial soundness, and valuations.
In addition to these steps, during the quarter we trimmed some positions for tax purposes, which were beaten down when self-help strategies didn’t progress as hoped—and where we now have less conviction. As we have been patiently looking for ways to deploy the proceeds of those sales, the temporary increase in cash was also a drag on performance in the fourth quarter.
Outlook
Without question, this has been a challenging environment for the Value Plus Strategy. While we can’t completely ignore the current environment—even if we disagree with some core economic assumptions—we must stay true to ourselves and our process. That’s why we believe in Heartland’s 10 Principles of Value Investing™, which are non-negotiable elements that we look for in any investment under consideration. As famed fund manager Seth Klarman has pointed out, the essential characteristics of value investing are “patience, discipline, and risk-aversion.” We believe turning our backs on those values in the short term is a sure-fire recipe for underperforming in the long run.
Bradford A. Evans, Senior Vice President and Portfolio Manager
Andrew J. Fleming, Director of Research, Vice President, and Portfolio Manager
Fund Returns
12/31/2023
| Since Inception (%) | 20-Year (%) | 15-Year (%) | 10-Year (%) | 5-Year (%) | 3-Year (%) | 1-Year (%) | YTD* (%) | QTD* (%) | |
|---|---|---|---|---|---|---|---|---|---|
| Value Plus
Investor Class |
9.59 | 7.73 | 9.36 | 5.24 | 11.39 | 6.51 | 1.83 | 1.83 | 6.99 |
| Value Plus
Institutional Class |
9.73 | 7.94 | 9.63 | 5.48 | 11.66 | 6.76 | 2.11 | 2.11 | 7.06 |
| Russell 2000® Value | 9.34 | 7.68 | 10.27 | 6.76 | 10.00 | 7.94 | 14.65 | 14.65 | 15.26 |
|
*Not annualized Source: FactSet Research Systems Inc., Russell®, and Heartland Advisors, Inc. The inception date for the Value Plus Fund is 10/26/1993 for the investor class and 5/1/2008 for the institutional class. |
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In the prospectus dated 5/1/2023, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.22% and 1.01%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class’ “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/reimbursement may be discontinued at any time. Without such waivers and/or reimbursements, total returns may have been lower. Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance for institutional class shares prior to their initial offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual’s return. To obtain performance through the most recent month end, call 800-432-7856 or visit Value Investing Manager Value Mutual Funds | Heartland Advisors. An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the Funds’ prospectus. To obtain a prospectus, please call 800-432-7856 or visit Value Investing Manager Value Mutual Funds | Heartland Advisors. Please read the prospectus carefully before investing. Statements regarding securities are not recommendations to buy or sell. Portfolio holdings are subject to change. Current and future holdings are subject to risk. The Value Plus Fund invests in small companies that are generally less liquid and more volatile than large companies. The Fund also invests in a smaller number of stocks (generally 40 to 70) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns. There is no assurance that dividened 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 Value Plus Fund seeks long-term capital appreciation and modest current income. The above individuals are registered representatives of ALPS Distributors, Inc. The Heartland Funds are distributed by ALPS Distributors, 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 2023 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved. Heartland’s investing glossary provides definitions for several terms used on this page. |
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