Russell 2000® Value Rebalance: Creating an Expensive House in a Value Neighborhood

As bottom up investors, the Russell reconstitution’s impact on our approach to managing money is negligible. Yet, while the annual process doesn’t affect our view of individual companies, we monitor the changes to gain insight into ramifications for the market in total.

A significant move this year, as you can see, is the breakout of REITs into a distinct category. For valuation-sensitive investors tied to the Index, the move comes at a challenging time. The trusts have benefited from an insatiable search for yield. We believe rich multiples from too much capital chasing limited opportunities are increasing downside risk. However, a contrarian approach can unearth some overlooked opportunities.

Corrections Corporation of America (CXW), a private prison owner/operator in the REIT space, has been under pressure as investors have grown concerned about the impact of sentencing reforms and presidential campaign trail rhetoric criticizing private prison usage. These concerns are overstated in our view. At 11x estimated 2017 funds from operations versus a peer average of 14x, the full story seems to be overlooked.

In addition to offering a 6% dividend yield, the company could see margin expansion and increased revenue from renting out existing facilities. Corrections Corporation’s residential rehab initiatives for former prisoners is another potential catalyst that isn’t showing up in the stock’s price.

We believe these are the types of REITs that will receive a closer look from investors tightly constrained to benchmark sector weights and will provide an additional tailwind to some of the businesses we own. We also see it as an example of how fundamental analysis has led us to value opportunities independent of the maneuvers taken by the Index.


Past performance does not guarantee future results.

As of 3/31/2016, Heartland Advisors on behalf of its clients held approximately 0.34% of the total shares outstanding of Corrections Corporation of America. 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 statements and opinions expressed in this article are those of the presenter(s). 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. The specific securities discussed above, 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 are based on Heartland Advisors’ estimates. Any forecasts may not prove to be true. Economic Predictions are based on estimates and are subject to change.

Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful. Value investments are subject to the risk their intrinsic value may not be recognized by the broad market.

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.

Copyright 2016 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

Definitions: Dividend Yield: is a ratio that shows how much a company pays out in dividends each year relative to its share price. Funds from Operations (FFO): is a figure used by real estate investment trusts (REITs) to define the cash flow from their operations. It is calculated by adding depreciation and amortization expenses to earnings, and sometimes quoted on a per share basis. Real Estate Investment Trust (REIT) is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. Russell 2000® Value Index: measures the performance of those Russell 2000® companies with lower price-to-book ratios and lower forecasted growth characteristics. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Frank Russell Investment Group. All indices are unmanaged. It is not possible to invest directly in an index.

CFA is a trademark owned by the CFA Institute.

©2016 Heartland Advisors


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