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Finding opportunity in small & mid cap stocks

By Chad Miller, CFA, Senior Portfolio Manager | 06/25/2024



The Thrivent Small-Mid Cap ESG ETF portfolio manager highlights the competitive advantages that small- and mid-cap companies gain when they create value for their stakeholders through service, culture and corporate governance.

Video transcript

Chad Miller: We're lucky at Thrivent to have the mandate that we should look out at the next 3 to 5 years and beyond for our clients to create value. That gets us out of the day to day, the week to week, the quarterly results, and we can focus on the things that are actually financially material over the long term.

As I think about active management, the biggest advantage is creating those structures to let the market give you opportunities. When it's down, you try and capitalize on those. And when it's up, it's perhaps the time to get more defensive, then you lean back on that structure and process you have in place as a company.

Charles (Chad) Miller, CFA
Senior Portfolio Manager
Video transcript

Yu: Hi everyone. I'm Michelle Yu, and welcome to Asset TV's Equity Summit. We are thrilled to have a number of portfolio managers, strategists and experts with us to talk about the landscape for stocks and where financial professionals can find pockets of opportunities.

Kicking it off for us now is CFA, Senior Portfolio Manager at Thrivent Asset Management Chad Miller. Chad, thank you so much for being here today. And I want to start with this. What makes small- and mid-cap sectors so promising in today's market?

Miller: Small- and mid-cap companies are a great place to invest. In fact, if you look back at the long-term history of the market, small- and mid-cap companies are one of the strongest-performing publicly traded asset classes you can find.

This is due to several reasons: these companies typically have a higher growth rate than the overall market; they typically are earlier on in their operational improvement runway and their business opportunity; there are more asymmetries in the small- and mid-cap market, so that means that the winners typically contribute more to the index performance relative to the average company; and there's more efficiencies due to less focus and less coverage of these small- and mid-cap companies.

At Thrivent, we have a dedicated research team that falls in small- and mid-cap space. This team is developing unique and proprietary insights on a daily basis that has led to the success of a number of our publicly traded funds already out there in the market today.

In 2022, we saw an opportunity to launch the Thrivent Small & Mid Cap ESG ETF to better leverage the insights and ideas of this team into a single product. We took our successful fundamental research process that we use at Thrivent across the platform and we added on to that our focus on stakeholder value.

So, we're trying to find those companies who are creating value for their primary stakeholders, those stakeholders being their customers, their employees, their communities, their suppliers; they’re addressing their environmental risks and opportunities; and they're doing all of this with effective corporate governance.

Looking at the small-cap space, we’ve started in an attractive area—it's ripe for asset management. And we have a proven team and process to create value in the small- and mid-cap landscape.

Yu: Now, we know that ESG metrics are pivotal to businesses. And my next question to Chad is, how do ESG metrics benefit investing in the small- and mid-cap markets that you focus on with the Thrivent Small & Mid Cap ESG ETF?

Miller: So, we generate alpha by stock selection and by investing in companies that are creating value for their primary stakeholders. If you look at how companies have evolved over time, differentiation used to come through physical assets, factories or investments in unit production. Today, value is being driven by intangible assets—it's service, it's culture, it's effective corporate governance and ways to differentiate in that way.

We focus on companies that can create value for their primary stakeholders. We're trying to go in and identify companies that can create a culture where employees want to work. We're finding companies that are creating value for their end customer. They are considering their environmental risks and opportunities, and they're doing all of this with effective corporate governance.

What we've found in our experiences is those companies who can create value for their primary stakeholders form a type of competitive advantage that is very difficult to replicate in the market.

One such example that you'll find in our Fund today is Modine. This is an example where the board came in and recognized the need for a new executive talent. So, they put in new executives that had come in from successful industrial companies, and they were able to identify a really strong R&D and innovation base in the employees. They invested more heavily in that, and they attached that to the customer focus areas where they could help solve their customer problems. So, they've seen very good success in HVAC, data centers, as well as heat transfer products in the early stages of their turnaround.

Another example is Celestica. This is a case study where the company has really gone in and invested to partner with their suppliers as well as their end customers to figure out the roadmap for their end components of where they're taking things on the cloud and connectivity side. They've been a trusted partner to develop AI hardware, as well as cloud and connectivity solutions. That has put them in the space to take market share and be a key partner to the companies that they work with.

Yu: How would you address the traditional volatility of small- and mid-caps?

Miller: We have a number of tools that we utilize to try to use the volatility that we see in the marketplace to our advantage. Thinking about research as a kind of pyramid: at the lowest level is the stock research where we’re looking at things like daily trading of the company, quarterly results—really kind of short-term focus indicators. Take that up a layer, and we get to the business—we’re looking at things like competitive differentiation, unit analysis, what the company can do from an operating standpoint. Take that up even a layer higher, and you're looking at the company analysis. This is where we get into things like culture, service, differentiation, capital deployment strategy and vision of the company. We try and spend a lot of our time focused on the top of that pyramid.

And then, as we get into our stakeholder analysis, we're looking for areas where potential risks might arise. I think that a lot of companies that have run into issues historically, it's due to a failing in serving one of their primary stakeholders. That could be an emissions cheating scandal where they're not following the applicable environmental rules, it could be a toxic workplace, it could be something where their customers are not seeing value. So, as we're stepping through our stakeholder analysis, we're trying to make sure companies are really addressing all of these risks.

So, if we've done our analysis and we think we have a strong company—we think they're identifying their risks appropriately and attacking those to make sure that they don't come up to negatively impact the stock of the company—then we can use that volatility to our advantage. So, when selloffs happen in the small- and mid-cap space that result in companies being overly penalized relative to large-cap peers, once we've done our work, then we can see that this is actually an opportunity because the business is strong—this company is addressing the risk, and this could be a good opportunity for us in the Fund to be invested in.

Yu: What timing do you expect for small- and mid-caps?

Miller: It's always difficult to predict timing of these companies in this market cap. But one of the things that we try to do is analyze and find companies that have a strategy to be successful, regardless of the macroeconomic backdrop. If it's in an expansionary time, they can grow, they can invest, they can launch new products and be successful that way. But we also want to see a company that has a playbook that, if the macroeconomic backdrop doesn't look as favorable, they can do things to be in an advantageous position to invest through that cycle. They might be able to acquire a competitor that’s not in good standing, or they might be able to reallocate capital back to shareholders. So, we start with trying to find companies that can be successful in a number of different macroeconomic backdrops, and that helps us not to have to play the timing game too much.

We've developed a number of tools recently to help us identify areas that could be of interest to us. We have a screening tool that we utilize to try to find asymmetric return companies, and we have another screening tool that identifies companies that are doing an especially good job with capital allocation.

Looking at how that has left our portfolio positioned today, we're finding opportunities in the technology sector. A lot of work around IT services and what has to go into the hardware stack from an on-premise to a hybrid to a cloud environment, we're seeing a lot of investment go into that area, and we have several companies who differentiate via service and serving that market. We also have several companies that are in the electronics and semiconductor market where their end markets have gone through a decline. They're close to the bottom of the end market, and now they're starting to see benefits from increased investments in AI and data centers and the like. Those are a couple of examples of how we are finding opportunities there.

Yu: Well, you talk about the tools. What are some of your best investing tips when it comes to small- and mid-caps?

Miller: I think, first of all, given the attractive area of the market that we've already covered, the first tip is to find some way to get exposure to the small- and mid-cap sector. The second is to try to find a team and an organization that you can trust to manage your money who will be there for the long term and has a proven process to create value out in the market.

I think that, if you look at Thrivent today, we've made a lot of investments in our fundamental research team. And specifically on this product, we've hired another portfolio manager to help us run it. Simon Bizien has come over just over a year ago, and he's been a tremendous asset to our Fund, helping to challenge us and identifying opportunities and getting better. We've also hired Addy Holmes as our director of ESG research on the product. She's helping us develop tools to strengthen our stakeholder analysis.

If you look at getting exposure to the market class, if you look at the proven team and process and you look at the companies that we are putting into the portfolio that can create value for stakeholders, I think we are very proud of the alpha we've been able to generate for shareholders so far, but we're even more excited about what the future holds.

Yu: Well, Chad, thank you so much for taking the time to speak with us here on Asset TV. And that will do it for me as well. I'm Michelle Yu, and thank you for watching.

This fund is different from traditional ETFs. Traditional ETFs tell the public what assets they hold each day. This ETF will not. This may create additional risks for your investment. For example:
 -  You may have to pay more money to trade the fund’s shares. This fund provides less information to traders, who tend to charge more for trades when they have less information.
 - The price you pay to buy fund shares on an exchange may not match the value of the fund’s portfolio. The same is true when you sell shares. These price differences may be greater for this fund compared to other ETFs because it provides less information to traders.
 - These additional risks may be even greater in bad or uncertain market conditions.
 - The fund publishes on its website each day a “Proxy Portfolio” designed to help trading in shares of the fund. While the Proxy Portfolio includes some of the fund’s holdings, it is not the fund’s actual portfolio.
The differences between this fund and other ETFs may also have advantages. By keeping certain information about the fund nontransparent, this fund may face less risk that other traders can predict or copy its investment strategy. This may improve the fund’s performance. If other traders are able to copy or predict the fund’s investment strategy, however, this may hurt the fund’s performance. For additional information regarding the unique attributes and risks of the fund, see the Principal Risks section of the prospectus.

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Miller joins “ETF 360” to talk active ETFs

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VettaFi head of research Todd Rosenbluth interviewed Chad Miller, Senior Portfolio Manager with Thrivent Asset Management, for “ETF 360” to discuss Thrivent Small-Mid Cap ESG ETF (TSME).

VettaFi head of research Todd Rosenbluth interviewed Chad Miller, Senior Portfolio Manager with Thrivent Asset Management, for “ETF 360” to discuss Thrivent Small-Mid Cap ESG ETF (TSME).