Admittedly, there were more auspicious times to have launched the Heartland Mid Cap Value Fund (ticker: HRMDX) than October 31, 2014. Mid-sized companies have historically outperformed large stocks over the long run, but that hasn’t been the case over the past decade, which witnessed a historic period of market concentration focused on mega-cap growth stocks. The past 10 years also saw mid-cap growth stocks prices return more than 168%, double the gains for the Russell Midcap® Value Index.
But in its first decade of existence, Heartland Mid Cap Value validated that old saying: “Time in the market beats timing the market.” The Mid Cap Value Fund Investor Class successfully navigated this challenging environment, beating most of its competitors on the Overall Morningstar Rating™ as of October 31, 2024 and even keeping pace with many mid-cap growth funds. The Fund received a 4-Star Overall Morningstar Rating out of 373 Mid-Cap Value fund, based on risk-adjusted returns.
What Makes Heartland's Process Stand Out?
A broader take on mid-cap value: The world of active mid-cap value managers is largely divided into two camps. On the one hand, there are dyed-in-the-wool stock pickers who focus on the absolute cheapest securities from a statistical standpoint (we call this deep value). Then there are bargain hunters who prefer high quality businesses trading at relatively attractive valuations (quality value). Both strategies can work over the long-term but relegating a strategy to one or the other makes for a bumpy ride for shareholders while writing off much of the investible universe in this space. Our Fund stands out because we are committed to having exposure to both deep value and quality value stocks at all times, believing our broader view of this asset class gives us more chances to generate alpha with less volatility for our clients. We call this the two-bucket approach.
A singular focus on stock selection: Over the past decade, stock selection has explained virtually all of our outperformance. We believe security selection is what we do best, so we’ve utilized technology and implemented rules and guidelines that helps ensure that stock picking is what drives our performance. For example, ideally, we want our sector exposure to be no less than 50% and no more than 150% of the same group’s weighting in the Russell Midcap® Value Index. If our weighting drifts above 150%, we must present tangible evidence to our Investment Policy Committee to justify why our allocation should be above 150%. The point is, we want our results to be a function of how well we are choosing securities, and not based on sector or industry bets where we have far less control.
We also leverage Axioma Risk Models in FactSet to help identify and address any unintended active risks in the portfolio. This analysis not only assists with identifying unwanted drivers of performance, but it also guides our prioritization of sources and uses of cash and position sizing.
What Makes Heartland's Team Dynamics Stand Out?
While a team of portfolio managers isn’t unique, how our team operates is. All the Portfolio Managers at our firm are first and foremost, analysts. To become a Portfolio Manager, you need to expand your coverage from a few industries early on, to essentially all sectors and business models. Once you have this ability, you can apply our 10 Principles of Value Investing™ to the needs of the portfolio. We think this has practical value in terms of focusing on what is most relevant at any moment, as well as having a positive cultural impact as none of our teammates are toiling away in sector specializations that may, frustratingly, rarely show up in the portfolio.
A willingness to constantly improve: While we’re confident in our stock-picking skills, we recognize most portfolio managers would say the same. At Heartland, we are rooted in seeking continuing, never-ending improvement (CNEI). When we’re wrong, we don’t try to downplay our mistakes. Instead, we see it as an opportunity to learn where we went wrong so we can improve our performance in the future.
Case in point: A few years after the launch of the Fund, around 2017, we recognized that we weren’t performing as we had hoped in our deep value bucket holdings. As part of our process, we assess companies based on both quantitative and qualitative factors. After a lot of soul-searching and analysis, we recognized that we weren’t getting the qualitative assessments “right” enough of the time. In researching what our winners and losers had in common, it struck us that our deep value stocks that were succeeding all had compelling, self-help strategies to improve their operations, industry standing, and profitability. That was a real, “A-ha!” moment for us. It taught us that we can’t simply invest in a company owing to valuations because deep value stocks can stay cheap for a very long time. Since that time, having a strategic self-help plan has become table stakes for any deep value company we are considering.
What Else Did We Learn?
For starters, we learned how useful the two-bucket approach is in not just opening up the opportunity set for potential investments, but in improving the shareholder experience. Within the first few years of our launch, the economy was in the midst of an industrial recession and OPEC declared war on the U.S. shale industry, which impacted the industrial economy. That was a huge segment of our investable universe. The volatility in the economy made for a bumpy market, which only highlighted the added value of diversifying between quality value and deep value stocks.
We also learned something about ourselves. All of our Portfolio Managers have unique styles that work cohesively together. They don’t think in exactly the same way, which we consider a huge plus. Over our first decade, the Portfolio Managers have learned how each other thinks and how they can use that to their benefit to be a more efficient and effective team. The combination of that plus our trust in our 10 Principles of Value Investing™ and two-bucket approach gives us confidence in our ability to deliver mid-cap value exposure consistently and effectively regardless of what the market has in store over the next decade and beyond.