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The Heartland Select Value Fund (HRSVX
) is a concentrated portfolio of deep value stocks, chosen from all market-cap sizes and industries. Hugh Denison, David Fondrie, and Ted Baszler took over the fund's management last March, following the departure of manager Gerry Sandel. Fondrie and Baszler were previously research analysts on the fund, which continues to follow a deep value focus.
This year through Sept. 30, the $92 million fund gained 6%, while its all-cap value peers were up 3.3%. For the three-year period through September, the fund rose 13.9%, annualized, vs. a 9.4% return for its peers. (Standard & Poor's recently reclassified the fund as all-cap value from large-cap value.)
The fund is more volatile than its peers, based on
standard deviation, 18.18 vs. 15.38. However, its annual
turnover is lower than its peers, 47% vs. 60.6%. Based on risk and return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 Stars.
Palash R. Ghosh of Standard & Poor's Fund Advisor recently spoke with Fondrie about the fund's investing strategy and top holdings. Edited excerpts of their conversation follow:
Q: What kind of stocks do you invest in?
A: We follow a deep-value strategy of investing in companies that are undervalued relative to their intrinsic worth. The stocks typically are attractively priced relative to their earnings, cash flows, and book values. While we don't have absolute quantitative parameters, we generally screen for companies with market caps of at least $500 million, stock prices of less than two times book value, and 12-month forward price-earnings ratios of below 20.
Before we invest, we identify a catalyst for each stock, like a new product or a new management team. We buy stocks that are starting to turn around or suffering depressed valuations due to short-term problems.
We invest in stocks of all market-cap sizes, and we seek a concentrated portfolio of about 35 to 50 stocks. Currently, we hold 43 stocks. All of our holdings are our best ideas, but our top-ten holdings are not necessarily our favorite holdings. They may have enjoyed good price appreciation. Typically, we like to start each holding at a 2% to 2.5% position.
We stress meeting with company managements. As a firm, we met with the managements of nearly 800 companies last year.
Q: How do the portfolio's cap-size allocations break down?
A: As of Sept. 30, we had 24% of our assets in small-cap stocks (below $2 billion in market-cap), 46% in midcap names (between $2 billion and $10 billion), and the remaining 30% in large-caps (above $10 billion). The fund's median market cap was about $3.1 billion.
Although we are fundamentally driven, we examine macro-economic trends, For example, over the past four years, small-cap stocks have performed extremely well. We now feel that sustained high oil prices and geopolitical uncertainties may lead investors to more stable larger-cap names. As a result, we are now more inclined to add to our large or mid-cap positions, rather than our small-cap holdings. Our large-cap exposure has nominally risen over the past year.
Q: What are the principal benefits of multicap investing?
A: We invest in the best values across all market caps, and keep our winners if they appreciate. Our more liquid larger-cap holdings help lessen the portfolio's overall volatility.
Despite small-cap's recent outperformance, we are still finding attractive small-cap value companies, although they were easier to find in 2000 and 2001.
Q: Are large-cap value stocks usually more difficult to find than small-cap value stocks?
A: Yes, generally speaking, it is much harder to find mid- and large-cap stocks that are trading close to book value. As a result, we find a wider range of p-e's among small-cap stocks.
Q: What are your top holdings?
A: As of Sept. 30, our top ten stocks were Potash Saskatchewan (POT
), 3.4%; Ryder System (R
), 3.4%; Motorola (MOT
), 3%; NRG Energy (NRG
), 2.9%; National-Oilwell (NOI
), 2.9%; Huntington Bancshares (HBAN
), 2.7%; Glatfelter (GLT
), 2.7%; Goodrich (GR
), 2.6%; Anadarko Petroleum (APC
), 2.6%; and UnumProvident (UNM
Q: What are your top sectors?
A: As of Sept. 30, our top sectors were materials and processes, 17.2%; autos and transportation, 15.6%; financial services, 15.2%; technology, 10.3%; utilities, 8.4%; and health care, 6.9%.
We don't place limits on any of our sector weightings.
Q: Your two top holdings, Potash of Saskatchewan and Ryder System, have performed very well this year.
A: Potash, a Canadian integrated fertilizer, industrial, and feed products company, is our top holding, primarily because it has appreciated substantially -- the stock has soared about 56% year-to-date. We initially purchased the stock about 18 months ago, when corn-product demand seemed to be improving. We then bought Potash and Agrium (AGU
), another Canadian fertilizer and agricultural company, when they were trading at historical lows.
Now that corn prices have collapsed, fertilizer stocks will likely correct, so we have slightly scaled back our exposure to Potash, as it has become highly valued. We still hold Potash because they are still have good fundamentals and strong sales from China.
Ryder Systems is one of the largest truck-leasing companies. It was a struggling company when we purchased it. We met with their management and were impressed by their restructuring strategy. They have executed their plan very well. Ryder's stock price has risen about 43% year-to-date, and they just released robust quarterly earnings.
Q: One of your top holdings, Motorola, has been up and down this year.
A: We saw a catalyst in Motorola when it named Edward Zander as its chief executive officer late last year. Over the past 18 months, Motorola has dramatically improved its handset business with new designs and a move to the higher-end market,where there is less competition. Motorola is a blue-chip, large-cap company with a great brand and a reputation as a technological innovator. We view it as a long-term core holding.
Q: Given rising interest rates, have you cut your financial services weighting?
A: We have been trimming our allocation to financial services, but not because of higher interest rates. Most of our financial holdings are insurance companies, which have been hurt by the ongoing investigations by New York Attorney General Eliot Spitzer. This unexpected move led us to trim our insurance holdings.
In contrast, we saw a great buying opportunity in casualty insurer Allstate (ALL
), when it was hurt by the Florida hurricanes. Allstate is unlikely to be tainted by the Spitzer probes.
Q: What are your sell criteria?
A: We will trim a holding if its valuation gets too lofty, as with Potash, and we may sell a stock outright if it reaches our maximum price. We also get rid of a holding when its fundamentals deteriorate or our original investment premise proves to be wrong.
For example, we recently unloaded AVX (AVX
), a capacitor and electronic-components maker. In the first quarter of this year, we had predicted higher demand for the company's products, but sales weakened in the second and third quarters. Although we liked their balance sheet and modest valuations, we didn't like their business climate, so we sold our position. We may revisit it later.
Q: Is your turnover low by design?
A: Yes, our annual turnover is typically below 50%. One of our most important tenets is tax efficiency for our shareholders.