Jenna Dagenhart: Hello and welcome to this Thrivent Asset Management Exclusive Masterclass. Joining us today, we have Kurt Lauber, Senior Portfolio Manager for Thrivent Large Cap Value Fund; Graham Wong, Senior Portfolio Manager for Thrivent Mid-Cap Value ETF; and Chris Parker, Senior Portfolio Manager, Thrivent Small Cap Value ETF.

Well, it's great to have you all with us today. Let's start with markets. Is it finally broadening beyond AI and mega cap growth? Are we entering a market environment where stock selection matters more than simply owning the largest growth companies? Graham, why don't you kick us off?

Graham Wong: Yeah, so on market broadening, we're definitely seeing some of it, but our outlook is it's not going to be a straight line. In the near term, broadening could take a break because of inflation fears and interest rate hikes, which is really driven by high energy prices. So, from here, the path really depends on where energy prices go. Longer term, I think we are early in the AI adoption cycle, so market broadening will continue as AI driven economic growth and productivity improvements impact more sectors going forward.

So, I'll give a few examples. The health care sector, we think that AI adoption is very positive there, for example, driving faster drug discovery. In financials, there's massive back office and other cost savings opportunities that could flow through. Lastly, even within the tech sector, we think there's broadening going on there as more companies catch up on the opportunity. So, the first phase of AI was the model training, so a handful of companies benefited. Now as we're going to the next phase or we're in the next phase of inference or running the models, a second group of tech companies are starting to benefit.

So, I'll give an example, Qualcomm. Qualcomm owns a lot of power efficient IP, intellectual property, from their smartphone portfolio over decades. And recently they won contracts from Meta and Amazon to use that technology to develop low power chips that supply into the data center market.

Chris Parker: Jenna, I'd argue that the market has been broadening for some time now. If we think back a few quarters, growth was trading at an atypically wide valuation gap relative to value, and large cap growth in particular was trading at a much wider than typical valuation premium to small cap.

What we've seen over the past few quarters is a combination of price performance and earnings growth has caused those valuation differentials to really migrate more toward normal.

And so, we've seen some dispersion in performance that's indicative of the market broadening. I think one of the other dynamics is beyond that, it became clear that economic activity was robust and in some cases accelerating. And along with that, investors began to question in some cases the sustainability of growth in returns for the various components of AI and performance in a number of sectors then began to catch up to those companies and stocks that were originally anointed as AI winners.

I would say additionally, as Graham mentioned, that within AI or within technology, performance has clearly been broadening. We've moved past that point where you just needed to pick the most obvious beneficiaries to having to do more digging, if you will, to find the winners.

And where the winners sit is in some different places. It's in areas that are tied to efficiency. It's in undiscovered beneficiaries from those who are becoming AI implementers, if you will. And so, from that respect, there is an environment where, to go back to your question about stock selection, it really is more of a stock pickers market and finding those unique company specific opportunities is more of what matters.

Kurt Lauber: Since I manage the large cap space where these mega cap growth names play, I want to give you a little different perspective. We did see the market broaden at the beginning of the year, but we've seen it broaden, we've seen it narrowed. Also, inside of AI, we've seen those exposures also move around a lot.

And I would argue that this volatility is the reason that you need active stock selection. And one more important thing that I think investors need to know is how AI is impacting the economy and how the AI is impacting the exposures in large cap value.

What we're seeing right now is those large cap, mega cap growth names like Microsoft, Amazon, and Google, they're actually some of the largest names in holdings in the Thrivent Large Cap Value Fund and the large cap value indexes. Also, the economy is being really driven by the strength in AI.

So, we really need to see the return on this AI spending. So, we need to see companies come out with good products. We need to see the efficiencies roll through. And the reason is because we're seeing higher rates. We're seeing driven by sticky inflation in the Fed, and that's really kind of pressuring the overall economy. We're seeing consumer spending impacted by higher gas prices. We're seeing business confidence low, but just really the non-AI spending is actually compressed.

And as Chris said, we did see value. Value has been good this year, but we've seen those small cap has done well. We've seen the low cap, low value names, and what we've seen is valuation compression. And when you have valuation spreads compressed, operating performance and stock selection matter even more.

Parker: I would say that AI investment has contributed to economic growth and in that respect it's helped with the broadening of the market, but I wouldn't say that that's entirely responsible. We have seen other areas of the economy start to generate their own growth and have their own kind of engine, if you will.

I think when we're thinking about the future outlook though, we're at a really interesting point in two respects. Investment in AI has become so significant for the companies that are the spenders that they've begun relying much more on debt to finance that growth. And as Kurt points out, if those investments do not provide clear and robust returns and justify the investment, the rate of that growth could clearly slow down or could certainly slow down.

Additionally, as Graham mentioned, there are concerns about inflation and clearly higher interest rates is on the front burner again. I think one could argue that the Fed really didn't bring down inflation truly under control before easing during the first tightening cycle. And if they do push much more aggressively to reach their target level inflation, we could be in an environment where AI sensitive names and AI sensitive areas of the economy are slowing at the same time that interest rate sensitive areas of the economy may be slowing as well.

So, specifically to bring that back to your question about stock selection, I think that each of us would argue given that outlook and given the compressed valuations that finding idiosyncratic company specific operational improvement is becoming increasingly important factor in terms of driving investment performance and driving opportunities.

Dagenhart: Let's talk about the valuation gap between growth and value. Is it too extreme and how much future success is already priced into today's market leaders?

Lauber: I can understand people's interest in this area and worries just because we've had such strong market performance, double-digit for the last four years annual performance out of value stocks.

And in this year, large cap value is beating large cap growth. It's interesting this year too, because usually value outperforms growth when the economy's doing well because we have more sectors that are economically sensitive like financials, industrials, materials and usually when tech does poor.

Actually, this year what we're seeing why value is outperforming growth is really inside of tech. So inside of value, we have more names that are kind of spending beneficiaries. We have semis and especially memory semis and hardware names, kind of the hardware names that were left for dead. While large cap growth has more software, some of those companies that are being challenged or displaced by AI, and they also have more of the heavy spenders like Microsoft and Amazon and Google. So, we have more of the spending beneficiaries inside value and that's why we've done so well this year.

Now it is true, value is still cheaper than growth, 20%, but over the last seven years, value has traded a lot cheaper than 20%. So, we're at the high end relative to growth.

And the last thing I want to mention on this extreme, what we've seen this year, we've seen all companies or many stocks do well, but what people don't understand is the underlying earnings have done even better. So, we've seen valuations compress. So, we're actually cheaper, 15% cheaper, the overall market right now than we were at the start of the year just because those underlying earnings have done so well even with the stocks doing well.

Parker: Maybe to think about the question slightly differently, Jenna, when those spreads were exceptionally wide, the market was very clearly communicating, “We believe there are a distinct camp of winners and a distinct camp of losers.” That was true in terms of valuation spreads between growth and value, and it was true in terms of valuation spreads between large cap and small cap.

To Kurt's point, those spreads have compressed, so I wouldn't say that that's too extreme at this point, but also the idea of just making a bet on small cap or on value purely based on cheapness is no longer as compelling a value proposition to be perfectly honest.

And so, I think now is the time to be a little bit more discerning with regard to which companies can drive better than expected operational improvement and can drive execution.

Dagenhart: Chris, as you indicated earlier, the Fed is working to control inflation and recently raised rates. If rates remain higher for longer, which sectors and companies are most likely to benefit?

Parker: That's a really interesting question. I'll try to think about that from the company point of view, but I think to put that a little bit in context, we do need to think about what that scenario would represent.

If rates were higher for longer, that realistically it would be because inflation has remained persistently high and sticky, and that's likely to mean upward pressure on cost structures and expenses for a lot of different businesses. And so, from a company point of view, companies that have truly a legitimate pricing power—so potentially less substitutable products, lower elasticity, just a better ability to pass through that inflation and maintain margins and maintain profitability—those are the companies that are going to be more successful in that higher for longer structurally higher inflation environment. And that's really more about necessarily the company than it is about the sector, to be perfectly honest.

I would say though, additionally, companies that are in the midst of positive structural change, sustainable self-help, we think that those types of businesses can outperform in a variety of different environments. And as we discussed earlier, we think that this is a particularly important moment for having that as a core part of your investment process.

And I personally think that one of the more appealing aspects of investing in small caps is that we can often find those types of situations earlier on in their evolution and earlier on in their development before that improvement becomes fully recognized in shares.

Finally, I would say it is important to think about in that environment of higher inflation, higher rates, who gets hurt? Companies that have high debt loads and potentially large maturities coming due in the short term, they could be under increased pressure. Additionally, companies with weak profitability or potentially those that are loss making can face challenges. And one of the risks for those types of companies is very much that those management teams might make decisions that trade short-term performance at the expense of long-term success.

For Thrivent Small Cap Value ETF and for our mid and large value strategies, sound capital structure and demonstrated profitability are really core to how we think about things and how we select stocks and evaluate companies. So, I think we're in a position where we can take advantage of those types of opportunities when they exist.

Wong: So, Chris covered a lot there in terms of picking stocks in a higher rate environment. I'm going to add some sector color. So, I think it really depends on the impact of higher rates on the economy and the shape of the yield curve.

So, if the economy stays strong and the curve steepens, we think financials and cyclicals are likely to outperform. So, banks would benefit from wider interest spreads, insurance companies would benefit from higher investment income.

Now, if the higher interest rates drive an economic slowdown, sectors like tech and industrials that are tied to more long-term mega themes like AI, power, and electrification could outperform. For TMVE, Thrivent Mid Cap Value ETF, we're focused on investing in the best ideas under either scenarios.

Lauber: I agree with Graham. It's the reason why rates stay high. One of the reasons rates are high right now is just the underlying sticky inflation. What's driving that? Energy prices.

Now, energy and large cap value is 7% of our index when it's only 1% in growth. So, if rates stay high because of energy prices staying high, we like companies like Conoco, Devon, Exxon Energy and Halliburton.

And what Graham also said is the tech group, it's not immune from higher interest rates, but it does have a lot of companies like Microsoft, Google, Amazon that are spending and they're less interest-sensitive. They have stronger growth and they have the ability to raise capital. So, we also think that the AI trade would keep going.

There's also some sectors that are just less tied to the interest rates of the macro economy like defense stocks. They're tied more to the election and government budget cycles. So, we like General Dynamics and L3Harris in that area.

And there's also cycles like the ag cycle has just been weak for many, many years and that's just tied to more cyclical crops and weather. And so we like names like CNH and CF Industries in those areas.

Dagenhart: Now, AI companies have been the leader of markets for some time now, but more recently investors are starting to question if those companies will generate enough earnings and productivity gains to justify the amounts they're spending or borrowing for growth. Is there an opportunity for value investors in AI? Kurt, why don't you kick us off with that one?

Lauber: Yeah, that skepticism provides the opportunity for value investors. I've lived through many cycles, the dot-com, the digital cycle, and the move to cloud. So, I have seen many cycles. And when people aren't worried, that's when there's no opportunity for value.

But right now they are skeptical and that's why we've seen names like Amazon, Microsoft, Meta and Google move into the value space and where we find that there's opportunity. Names like Amazon, Microsoft, Meta and Google, they're trading near the market average multiples on the EV/EBITDA, but people are worried about their spending levels. So, we do need to see good returns on that spending, but that's what's putting the opportunity for value investors.

We're also inside of AI, where can value also do well in some traditional value sectors like utilities. So right now utilities are, because of “Not in My Backyard” and going into the election cycle, there have been some pressure on some of the names we like Vistra and Constellation, but we think the really strong demand for AI will be also a strong demand for electric utilities and for names in that sector.

Parker: The reach of AI, Jenna, is so broad at this point, and ultimately, we're still very early on in its evolution that it in some ways is creating investment opportunities in a variety of different areas.Certainly in areas that would be traditionally considered value such as utilities that Kurt mentioned. But also as form factors and architectures within the data center change and needs for those companies evolve. That creates opportunities in the technology space, including as Kurt mentioned, as it relates to memory and some areas that are typically viewed as value-oriented technology.

It also creates opportunities in areas such as industrials with companies that are tied into electrification, that are tied into electrical efficiency. So there's a wide area of places to look for this initial evolution.

I think from a small cap point of view, one of the interesting things is that AI kind of evolution and build out can create opportunities where you might have a smaller, more focused company that is well-positioned to take advantage of or capitalize on an evolution in that architecture. And in some cases, because of the size of the starting point, those can be very meaningful step changes in terms of the revenue growth and profitability of those companies.

I think beyond just the idea of the AI build out, we are at a point where we're starting to see companies who are implementing AI tools to improve their workflows, to reduce their costs, to improve service, effectively to deliver for customers in more effective ways and potentially in ways that improve earnings power or increase competitive advantage. And that's occurring somewhat unevenly. It's occurring especially somewhat unevenly in the small cap universe.

And in some cases, those are companies that also might have been viewed initially as AI losers who are then taking a lot of those tools, potentially reinventing their businesses and expanding their duration. So, I think there are, in traditional value sectors, a wide variety of places where investors can benefit from the impact from AI.

Wong: Yeah. So, going back to the question about whether we'll get the returns from all these large AI investments, I'm going to throw some numbers out.

I recently read that AI revenues, excluding China, are tracking to be up 330% this year to $200 billion plus. So, the math to get to an adequate ROIC is actually $800 billion revenues, which is four times from where we are this year. It sounds like a high bar, but in other ways to think about it, it just means doubling in AI revenues for two years.

I'm a believer that we're very early in AI, so that does not sound like a bar that cannot be achieved. The difficulty, however, is that the sentiment around the AI space and AI stocks are very, very high. So, it does take some stock picking to invest around it.

We have seen companies that report 50% growth in revenues beat street expectations and yet the stocks trade lower. So bottom line is we're bullish on AI theme, but not bullish on every AI stock.

Now, in terms of investing in AI within the value sectors, I think the opportunity isn't as much in the builders of AI anymore, but more the adopters of AI, which Chris talked about a little bit. I'll just give two quick examples.

Cisco is a food distributor that is now using AI to optimize their truck routes. They recently announced a $500 million savings program that translates to about 300, 400 basis point margin expansion so that we're very positive on that name.

AIG in the property and casualty insurance sector, they are early adopters of AI and we think that it'll help them underwrite these complex global insurance policies faster and also improve the claims processing and other labor-intensive functions.

So yeah, we see plenty of opportunities to invest in AI within value.

Dagenhart: Sticking with you, Graham, the economy has shown a lot of resiliency over recent years. Which value-oriented sectors are best positioned to benefit from continued expansion in the economy?

Wong: We like materials, energy, and industrials around three themes. We like materials and energy because of a strong supply and demand setup. There is demand pull from not only the AI build out, but just in electrification in general. So, think EVs and industrial automation.

But even more importantly, we see a lot of discipline on the supply side. So historically think the energy sector. This sector really suffered from a lack of supply discipline, but they really seem to have learned from it and probably forced to do so because of this constant terminal value risk overhang from all the green energy talk. So, they've swung the other way and they're now focused on ROIC, which we really like. It also doesn't hurt that interest rates are high right now and there's a lot of macro uncertainties, which keeps a lid on any speculative supply projects.

Speaking of energy, we also like the theme of energy security. Given the recent wars, the Strait of Hormuz challenges, countries want to diversify their sources of energy and become more self-sufficient if they can. We think all surface companies and engineering and construction firms will benefit from this theme.

Lastly, I think Kurt talked about defense companies earlier. We also like defense companies. Warfare is changing rapidly with the rise of drones and manned vehicles and robotics. There's a lot of innovation that benefits defense companies.

They recently sold off on fears of deescalation of the wars and election fears. However, just inventory replenishment of what's used in the wars will take multiple years. So, we don't think we're at a peak on defense companies yet.

Lastly, our allies want to be more self-sufficient in this area as well, so I expect international sales to be very positive for the defense companies.

Lauber: Just like Graham, large cap value likes materials, energy and industrials, but I'm not going to go too deep into that since Graham just did. What I'd like to talk about a little bit more is what's been driving the growth. And I think the theme here as you can hear is AI.

So, we're still focused on tech if the economy stays strong, but we have moved a little bit more to the enterprise, as we're now deploying AI into the enterprises and rolling out these agentic models, different companies should benefit. Some of those companies are like TD SYNNEX that have their feet in both sides. They provide products to the large cloud providers, but they also provide products to enterprises.

And enterprise switching and storage should also benefit. So, we like companies like NetApp and Cisco that provide their products to the enterprise base and not just the cloud providers. Tech is the second-largest sector in value now, so we need to keep an eye on that.

The largest sector is financial. So, if the economy does stay strong, financial should do well because they'll be able to expand their bank lending. Credit should stay strong. We should have a recovering IPO market. And there we like Wells Fargo and the large diversifieds. We like Morgan Stanley and the capital markets. We like Schwab [Charles Schwab] and wealth management. And if credit does stay strong, then Cap One [Capital One] should do well.

Now, if the economy improves because energy comes down, we get a little more interested in the consumer discretionary spaces, especially housing. So, housing has been pent-up demand there. So, we like D.R. Horton and Lowe's. We just haven't moved in there fully because we're having a hard time seeing how rates can come down.

We also would like more some of the consumer discretionary needs in travel like Delta Air Lines and Wyndham and also in the transportation space in J.B. Hunt and CSX.

Parker: I would start out, Jenna, by saying that small caps in general have historically had a higher beta to the overall domestic economy. And so, a continued robust expansion would tend to favor small caps based on those relationships.

That obviously certainly does go both ways if we do see a slowing though. I would push back a little bit on the idea again of there being growth and value sectors. I think that those lines have become very blurry at times and they've certainly become blurry recently. We talked about utilities, we talked about technology, things of that nature.

Even within technology, software used to be very much a growth sector and now because of concerns about AI and terminal value risk, software is starting to look a lot more like value. So, we tend not to quite think about it in those types of terms. But specific to your question of what we like in an environment where the economy continues to expand. We like industrials and I think both those that are related to or have aspects that are tied to AI-related demand build out.

But I think also where we have end markets that are either in the early stages of improvement or that are showing some signs of bottoming. Kurt mentioned previously the idea of the agriculture cycle and agricultural machinery. That's a market that has been weak for quite some time. It's arguably less tied to the economy, but we are seeing the age of that fleet starting to lengthen fairly significantly. There's efficiency that occurs in those machines, and that's a place that we think is interesting. We like AGCO in that space that not only has the potential for a bottoming to improving overall cycle, but has some company specific market share opportunities as they've launched the number of products and they've changed how they go to market and interact with farmers. They also have a really interesting and somewhat unique retrofit opportunity that does create a lot of value and a lot of stickiness for farmers as well.

Staying within the industrial space, we like a company called Terex that historically has been a construction machinery business. They've evolved their portfolio to areas that are much more consistent, higher margin, just solid growth, things like fire trucks and refuse. And that migration is really underappreciated by investors at this point, but that's something that we think is interesting.

I would also argue that there are some opportunities in the consumer space as well. If we think about a robust economy and what that means, even in the context potentially of higher interest rates, that probably means a stronger labor market and potentially a stronger skilled blue collar labor market if we think about what's driving the strength in that economy. And we think that that can create opportunities in certain types of consumer names.

We like Levi's, the blue jeans company, I think we all kind of know. They have a number of programs that they're working through to improve structural profitability, to increase their margins. And we also believe that we're early on in the idea that denim is becoming a little bit more fashionable. It's not all about athleisure in terms of what consumers are wearing at this point.

And not only that, but the types of jeans and the use cases, the occasions if you will, are really broadening out. And so rather than you having two or three pairs of jeans in your closet, you may have five or six because you want different silhouettes and different fits. And that's something that we think is early on in its evolution and something that we think will benefit Levi's.

Dagenhart: Next, what separates a temporarily mispriced business from a company facing permanent challenges? Kurt?

Lauber: Yeah, that's what we do every day is our fundamental analysis. We're just trying to look at what's challenging a company and are they going to be basically what we call value traps?

And we do that through our analysis, bottom up stock picking. And we're seeing a lot of opportunities now because of the fear of AI. It's disrupting a lot of business models, disrupting the software sector, the services, companies’ wealth management, freight and logistics, and even the music industry.

So, we went and looked at Warner Music. A lot of people are worried about the label companies because there's a lot more inventory coming on. Matter of fact, Tom Lieu, who I work with, sent me a country song and I'm sure I'm the only one who listened to that song, but he developed it on AI and I'm sure his kids didn't even listen to it.

But there's just a lot of talented people out there, but AI is going to make people even more talented. However, you need the labels to get people interested in your music.

And so, we did dug a little more and we really were really interested in how early we are in the music cycle and it's undervalued. We're paying less today than we did even 20 years ago. And then we started looking at the AI disruption and we actually found out that AI could be a benefit.

A lot of people like to mix music, but they want to use a talented person's voice or this music. So, we're starting to see that Warner Music has made some contracts with companies that develop AI music. So, it's another revenue engine. So, we don't think it's going to impact their inventory. We actually think it would be positive for the revenue model.

Parker: For us and the way that we approach that for Thrivent Small Cap Value ETF, we have five things that we tend to focus on when we're trying to assess this. The idea of duration, is this clearly something that's short term in nature? Is it something that's more structural and secular? We prefer to look at more short term in nature. We will dig into secular every once in a while though.

The idea of recognition, is the management team realistic in understanding that there is a challenge and really formulating a plan to address that potential issue and potentially capitalize on challenges?

Third item would be the idea of control. Is this something that the company can realistically respond to where actions that they take can influence the outcome? Or is it an external factor, quite frankly, where they may not be able to control their destiny at this point? Those are very hard to assess if you can't control your destiny.

The fourth item would be the idea of capability. Does the company that we're looking at have the capabilities, the tools, the resources, the internal talent to address the challenges? And as Kurt mentioned with Warner Brothers, for example, to even sometimes capitalize on disruption?

Finally would be the idea of impediments. What are the internal or the external factors that might prevent a company from being able to address the difficulties? That might be a difficult balance sheet. Sometimes it's hard to fix the business, face a challenge and fix the balance sheet. It might be a cost structure that's sticky and hard to move off of.

I think one example for us that demonstrates that process is a company called Parsons Corporation. They're a government contractor that operates in a variety of different areas for the federal government and state and municipal governments and other areas.

And there were two uncertainties that developed there. The first one was the idea of DOGE and the idea that government contracting would change in a meaningful and potentially permanent and really adverse way so that their growth rate and their profitability would face significant pressure.

The second one was a little bit more company specific where they had some issues with some legacy contracts that they were working to complete and they had to take some charges around that.

On the government contracting question, our research led us to the conclusion that the impact from those changes was ultimately fairly narrow and that Parsons was actually well positioned in a number of areas where spending would remain robust.

They operate in areas like missile defense. They operate in areas for the government like cyber and cyber offense and defense. So, we kind of thought that the investors were kind of throwing the baby out with the bath water there.

Additionally, the company at that point had taken some actions to shift focus and really shift approach as well where they needed to take advantage of some of the shifts that were occurring in procurement and understanding how to manage that from a government services point of view.

And then as it related to the legacy contract issues, the charges that they took were related to some fairly old contracts that in most cases predated the existing management team. So, our work led us to believe that those were truly one-off in nature and that the company had actually already taken the steps to migrate away from the type of work that led to those charges, changed the ways that they managed risk, changed the way that they structured contracts and how they priced.

And we felt that after researching both of those items, the market was simply being way too pessimistic in terms of the outlook for this company and their ability to return to attractive levels of growth and return to attractive levels of profitability. And so, we think that's an interesting idea and a good demonstration of how we try to tackle that issue.

Wong: So, I think Chris did a really good job of talking about his framework on how to analyze potentially broken companies. I'm going to give a quick example for us.

Simon Property Group is a shopping mall REIT. We tend to see opportunity when people start talking in absolutes. Now in this case, people were saying malls are dead. So, our job was to figure out whether malls can pivot their strategy in a challenging retail world? So, for example, can they pivot to focus on experience to drive traffic? Can they pivot to add value in an omnichannel world? Our non-consensus view after our research was that A malls would survive and consolidate traffic from the dying B, C malls, and Simon Property Group would be a big winner from it.

So here, the important is understanding the assets, the quality of the assets, good assets that add value to their customers will generate good returns for the shareholders.

So, in this case, Simon Property Group has the best malls and we've been very happy shareholders of SPG.

Dagenhart: Now, as the market leadership broadens, is active management becoming more valuable to investors, Kurt?

Lauber: Yes, that's what I've been arguing here. Not just if the market AI broadens or narrows, but we've seen increased macroeconomic risk. We've seen increased geopolitical risk and large cap values processes take advantage of these dislocations and confusion through stock selection.

Parker: For small cap, I'll kind of approach that in a couple different ways. I think small cap is a place where there's a somewhat persistent argument for active management. If you buy a small cap index, about 30% of that index at any point in time is comprised of companies that are not profitable and probably haven't been profitable over the past three years.

And that statistic is somewhat consistent over time. And those non-earners in the small cap universe tend to underperform earners over time.

So, as an active manager with an investment process that does focus on better quality companies with the track record of profitability, we think that there's a clear benefit over time to an active approach in small caps.

I think beyond that, there's a really strong case that can be made for active management in small caps during particularly dynamic environments. Kurt mentioned some of the uncertainties that exist right now: broadening activity, changes in leadership, a lot of exogenous factors as it relates to the economic and sector environment.

And being able to kind of dig in and identify winners that have control of their own destiny, that have their own unique opportunities to improve their profitability and that are still undiscovered is a clear kind of strong reason for small cap active management. And I think that's particularly present at this point in time.

Wong: So, I really love this question. As you know, there are many different shades of value investing. I would describe ours as value with a catalyst. So, we buy undervalued companies, but with catalysts to unlock that value, so to avoid the value traps.

We measure value relative to the business model, which we assess based on the ROIC or return on invested capital of the company.

The last thing I would differentiate us is we do a lot of cyclical investing. I think some of our peers might avoid it from a risk perspective, but cyclical sectors make up a big portion of the value benchmark and we don't shy away from it. We see it as an opportunity.

So, we're constantly looking for industries or companies that are near a cyclical trough to invest in with the preference—now this is important—on stocks where we think the next cycle is going to be better than the prior cycle.

Lauber: Thrivent Large Cap Value. We look at value a little differently than other value investors. And we look at the return value trade off. So well some value investors say, "I just won't buy a stock or a company that's not below an index average," we look at the future returns of that company.

We think a company with good returns deserves a higher value. Therefore, we're looking for that mispricing between future returns and value and we'll buy anything really we look at below that curve, anything that looks like there's opportunity where other value investors don't see it.

I'll just give you a quick example, two quick examples. Delta Air Lines. Everyone really thinks airlines is a poor return business. Right now, Delta Air Lines is trading at a similar value that it has over the last six years because its returns are the same. However, many other airlines are operating below their cost of capital. The operating free cash doesn't meet their capital expenditures. Delta has found a way to really manage this business that has been seen as a poor business. Right now, it's being pressured by higher fuel prices and things like that, but we think, going through the cycle, they will earn higher returns than they ever have in the past, and therefore, they deserve a higher valuation.

As Graham mentioned, we do a lot of cyclical investing, and right now we've seen that the ag cycle, it's been very poor for many years. We know that it's just a cheap stock on low returns. We look out further, and we think that the inventory now has been down to a level that from this point on, that they can grow and earn returns higher next cycle just because of all the technology advances that are needed in the ag sector. So, we like CNH Industrial and CF Industries in this space.

Parker: For us, small cap, as it relates to value, is really a different world, and our approach attempts to reflect that.

If we think about the fundamental range of outcomes, in small cap, that's just much, much wider. These are smaller, less diversified companies. The impact of exogenous factors can be much greater than some of the businesses that Graham and Kurt would look at over time. So, when we're thinking about things, we demand a much larger margin of safety in our process to reflect that. And we do a lot of work to understand what can go wrong and to understand downside risk.

I think as well, in large cap and mid-cap, companies are well covered, they're well understood, everyone's kind of got their eyes on them. Small caps can have a little bit of an attention deficit syndrome. Good and cheap, quite frankly, really isn't good enough much of the time.

So, our process tries to address that in two different ways. The first is that we actually look for companies that can grow value over time so that even when the market is not necessarily recognizing undervaluation and potentially improvement, the earnings base is keeping up so that you're still kind of swimming with the current, if you will.

And then we also really do put a lot of focus on the idea of structural change that will generate increased investor attention, faster earnings growth, higher returns, better cash realization, things of that nature, that can drive rerating. And a lot of that work is more company-specific in nature.

The other thing I would say as it relates to small cap is that management teams can really have an outsized impact on the performance of the business and then ultimately the performance of the stocks over time.

And that works in both directions. So, evaluating the management team, certainly at a C-suite level, but underneath that as well, and being very discerning about management capability and management alignment, that takes on greater importance in our universe, I think, and when we're evaluating companies.

Dagenhart: Finally, what's your execution strategy and framework for picking value investments?

Wong: Our process is valuation, operating and sentiment, but we really spend 90% of our time studying the operating bucket, which is the industry itself and the company's competitive positioning within the industry.

We really scrub the industry dynamics hard in terms of understanding: is the industry changing, supply and demand factors, and things like that. And then lastly, as I talked about earlier, digging into the catalyst for operating improvement.

Now, on valuation, just to give a little bit more color, we focus on analyzing and getting to a reward-to-risk metric. So, we look for stocks that have an acceptable downside, call it 15 to 20% usually, and then for a reward risk of about three times or more.

And then lastly, on the sentiment bucket, what's important here is, as value investors, we avoid the consensus view. If everybody likes something, that's when we run away.

Parker: For Thrivent Small Cap Value ETF, we share the core drivers of the idea of valuation, operating and sentiment or catalyst. I think we express those a little bit differently.

When we think about valuation, we think about the idea of margin of safety, as I mentioned, and what we term as substantial undervaluation and really asymmetric risk-reward. The idea of heads, I win; tails, I don't lose that much.

When we're thinking about that, we're very much intrinsic value type of investors. So, we're thinking about that price that we can pay relative to what we think the discounted value of the cash flows are for the company. Or some multiple-based version that expresses that, which is slightly different, but that's the idea. We do have a broader universe. We should be able to find things that are significantly undervalued.

When we're thinking about the idea of improving operating fundamentals, we kind of work through everything that Graham talked about in terms of the idea of industry structure, changes that are occurring, company positioning. But in particular, for us, given the attention deficit aspect of small cap that I talked about, I mean, we really do spend a lot of time looking for underappreciated structural improvement in those operating fundamentals, because in many cases, just having the cyclical kicker in our universe isn't quite enough to drive out performance.

As I mentioned previously, capable and well-aligned management teams are a big part of our process. The ability of businesses to grow over time, that helps us keep up when companies are not necessarily getting the attention that we think that they deserve

But it also helps us avoid places where there might be secular risk or value trap risk. Generally speaking, companies that are growing earnings or that we think are going to grow earnings over time are less likely to be exposed to those types of dynamics.

And then, as Graham mentioned, poor or undemanding sentiment and having a differentiated positive view is the last but really key part of our process, because if we've worked through everything that I've talked about and it kind of looks and feels like everyone else appreciates and understands those things, then it's not entirely clear what's going to occur that's going to drive that particular company and that particular stock to outperform.

Lauber: Our framework in large cap value is very similar to Graham's, mostly because we worked together for many years, but it's very helpful as we overlap about 30% of companies we can invest in.

So, I just discussed a little bit about our return value trade-off is our process, large cap value, but we also have industry expert analysts that have been in their field for long periods of time that understand their companies. And we also require that they have an investment process.

Now, how do we execute on that? Graham kind of mentioned, we ask the analysts to rank their companies on valuation, operating performance and sentiment, and then a catalyst unlock the value.

So, valuation, we discuss, it's returns versus value. Operating performance is 90% of what we do. Where are our operating metrics for the companies differ from other investors?

And lastly, sentiment. We do like companies that have been neglected, but that's why we also look for a catalyst. They can stay neglected for a very long time and be value trapped. So, we ask our analysts to have a catalyst to unlock that value. How are other investors going to see that it's a value?

A good example of this was Entergy. So for the last 10 years, electric utility demand has been flat. Mostly, we've seen the supply, we've seen nuclear taken out of the market, we've seen coal plants shut down. Natural gas plants have been tough to be built, and we built a lot of inefficient energy in both wind and solar.

We looked at this industry and thought, "Hey, there's an opportunity here because demand's been poor for so long," but we started hearing things about onshoring and EVs, and also cloud and data centers at the time wasn't AI yet, but cloud data centers were also in big demand.

So, we asked our analyst, " We think there could be a good opportunity for improvement in returns and improvement in growth in this sector. What's your investment process?" His investment process was, "Go look at those regulatory environments that are poor but could improve."

And we looked at Entergy. It wasn't getting good returns due to all the hurricanes. It just wasn't allowed to get the returns based on the money they were putting in to prepare for the hurricanes.

However, we started hearing some changes from the government officials down there, the regulators, because they wanted the growth to come into the area of Louisiana and the panhandle. So, we got very interested in the stock, and we made an investment.

Then a few months later, you started hearing about industrial companies moving into the area, then the regulatory environment changed for them. They were allowed to recover returns on those hurricanes. They were allowed to grow.

And then the stock really took off. When we started, data centers starting moving in there because it's in such a good position for natural gas coming from Texas.

Dagenhart: Well, I wish we had time for more, but we better leave it there. Kurt, Graham, Chris, thank you all very much for being with us today.

Lauber: Thank you, Jenna.

Wong: Thank you, Jenna.

Dagenhart: And thank you to all of our viewers out there watching. Once again, that was Kurt Lauber, Senior Portfolio Manager, Thrivent Large Cap Value Fund; Graham Wong, Senior Portfolio Manager, Thrivent Mid Cap Value ETF; and Chris Parker, Senior Portfolio Manager, Thrivent Small Cap Value ETF. And I'm your host, Jenna Dagenhart with Asset TV.