Heartland Value (ticker symbol HRTVX) is a mutual fund with approx. $1.2 billion in total assets managed by Bill Nasgovitz and associates. Currently, Morningstar rates the fund Two Stars / Bronze in the US OE Small Value category. The latest Morningstar analyst report on the fund titled “The fund has plenty of positive attributes working in its favor” was published in May 2012. At present, this no-load fund has an total expense ratio of 1.1% and charges a 2% redemption fee on shares redeemed or exchanged within 10 days of purchase. Let’s assess the fund’s performance using the Alpholio™ methodology.
First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:
The chart shows that in the analysis period the fund generally underperformed its reference portfolio.
This is further illustrated by the cumulative RealAlpha™ chart:
In the chart, the lag cumulative RealAlpha™ curve is, for the most part, below the regular RealAlpha™ curve. Typically, this is an indication that the fund manager made major directional bets that significantly departed from the fund’s holdings in the immediately preceding time window. Unfortunately, these actions did not contribute RealAlpha™; on the contrary, an investor would be better off sticking with the lag reference portfolio (see the FAQ). With respect to cumulative RealAlpha™, the analyzed period can be divided into four distinct sub-periods:
- From early 2005 to early 2007, the cumulative RealAlpha™ of the fund was largely flat
- In 2007 (well before the market downturn), the fund lost approx. 25% of cumulative RealAlpha™
- In 2008-09, the fund’s cumulative RealAlpha™ rebounded but did not reach its peak level from early 2007
- From early 2010 onward, the fund had a negative trend in cumulative RealAlpha™.
The overall statistics further underscore the unimpressive performance of the fund:
At close to 21%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was significantly higher than that of the overall stock market. The volatility of the reference portfolio was about 2% lower than that of the fund. The discounted annualized RealAlpha™ of the fund was approximately minus 2%, which was mostly caused by the substantial loss of alpha in the in the second sub-period described above. At about 1.06, the fund’s RealBeta™ was slightly higher than that of the market, which was also reflected in the higher volatility.
The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:
The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from its smoothed approximation with an exponential moving average (EMA), depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.
The signal would allow an investor to avoid the significant periods of the fund’s underperformance according to the smoothed RealAlpha™ measure, while capturing a couple of periods of outperformance in 2006-07 and 2009-10.
The following chart shows the major investment “themes” of the fund over time:
In the analysis period, the fund held equivalent equity positions in IWM (iShares Russell 2000 ETF; average weight of 24.4%), VBK (Vanguard Small-Cap Growth ETF; 20.4%), JKJ (iShares Morningstar Small-Cap ETF; 8.5%), VPU (Vanguard Utilities ETF; 8.2%), and EWC (iShares MSCI Canada ETF; 7.4%).
For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent cash position in IWO (iShares Russell 2000 Growth ETF; average weight of 4.5%).
As indicated by a recent MarketWatch article, the fund also had a significant recent exposure to gold, which is illustrated by an equivalent position in GLD (SPDR® Gold Shares ETF; most recent weight of 17.7%, which was in increase from 12.9% in the previous month of the analysis). This increased exposure to stocks of gold miners had a negative impact on the fund’s performance in light of a recent significant decline in the price of gold.
Morningstar’s analyst report on the fund stated that:
“Experience and execution are this fund’s strong suits… Nasgovitz and his team employ a valuation-conscious approach to small-cap investing… While the process is sound, execution has been spotty.”
This analysis clearly demonstrates that the strategy of the fund could easily be replicated using a relatively small number of exchange-traded products (ETPs), and with a better performance (higher return with smaller volatility). As a matter of fact, in the last month of the analysis just three ETPs, with collective weights of 98.2%, accounted for almost all returns of the fund. Investors could use the results of the ongoing Alpholio™ analysis to construct a substitute portfolio of liquid, low-cost instruments that provide a higher diversification (as of 3/31/2013, the fund’s top ten holdings accounted for over 21% of its assets).