PARKER: Thrivent Small Cap Value ETF.  Ticker symbol TSCV. The fund was originally launched April 1st, 2022. My name is Chris Parker. I have an MBA from Northwestern University, and I have co-managed the fund since February 2023 with my partner, Charmaine Chan.

CHAN: And I'm Charmaine Chan. I have a Ph.D in biochemistry and biophysics from Yale. As of November 14^th, the fund is operating as an actively managed ETF.

When we think about TSCV versus the category of small-cap investment strategies, a few things stand out. We're more concentrated than many actively managed funds. We focus on having 50 to 65 positions at any given time. Compared to other actively managed funds, which on average has 217 positions and on median 98. When compared to small-cap value indexes, we can focus on investments that offer the most attractive risk reward opportunities. We believe this concentration allows us to focus on investing in what we believe to be the most compelling opportunities.

PARKER: We think about valuation and undervaluation a little differently. We don't think about valuation as a single point estimate. We think of valuation as a range of potential outcomes. And when we're thinking about purchasing shares in a particular company, we take into account how wide that distribution of outcomes is and what level of discount gives us a sizable margin of safety.

Another aspect of our approach is we're highly cognizant of downside risk. We focus on limiting downside risk with the types of companies that we seek to invest in and how we evaluate downside scenarios in our evaluation work and in portfolio construction.

We believe that this will help us generate attractive risk adjusted returns for our investors over time.

CHAN: Even though we are value investors, we focus on companies that grow value for shareholders over time. This allows us to be patient and being able to take a longer-term view as a key advantage. Many times when people think of value investing, they think of low price-to-earnings ratio or some metric of depressed market versus fixed value asset. These can be helpful as starting points, but they can steer the portfolio towards low quality and cyclical businesses.

PARKER: We are margin of safety and intrinsic value investors. We focus on sound companies, and we try to estimate the underlying value of a business as determined by the present value of its future cash flows. And then we look to purchase at substantial margin of safety such that it's a heads we win, tails we don't lose that much scenario.

We're looking for sound and improving businesses that grow value over time, are led by capable and well-aligned management teams when we think they are substantially undervalued. If we unpack those characteristics a little bit further, for sound businesses, we’re looking for companies that have a demonstrated track record of attractive returns on invested capital, profitability and free cash flow generation. And where variables such as industry structure and company strategic positioning lead us to believe that those financial characteristics will be sustainable over time.

CHAN: For improving businesses, ultimately, we're looking for companies where the operational dynamics have a favorable direction of travel. In some cases, that is the business that is under earning in the midst of a cyclical improvement. Sometimes it is otherwise a solid company that is experiencing surmountable difficulties. And where we believe the business is on the path to recovery. What we really love to find are businesses that are in the midst of a sustainable structural improvement in growth rate, profitability, returns and cash flow generation. These are terrific investments as investors not only benefit from strong fundamentals, but also get the added benefit of a positive rerating in the valuation of the company.

PARKER: In our view, management is incredibly important and this often doesn't receive sufficient focus. We think of the value of companies as a distribution of outcomes. And we believe that when you invest in less capable management teams or those with distorted incentives, that increases the odds of a poor outcome. That may come in the form of ineffective operational execution, poor strategic decisions, or value destructive capital allocation. Any of which may lead to weaker performance of the business and underperformance of the company's shares. On the other hand, investing alongside capable management teams with well aligned incentives reduces that risk of adverse outcomes, in our opinion. And those management teams often make value creating decisions that are positive surprises. In those cases, the chances of a better-than-expected performance of the business and outperformance of the company's shares increases in our view.

We also look for companies that grow value at attractive rates over time. As value investors, we think that patience and the ability to take a long-term view are key advantages. However, the time value of money risk is real. So, we focus on investments where business value to shareholders grows over time at attractive rates through cash generation and growth and earnings power.

This allows us to be patient.

CHAN: Let's use two different companies as examples. They're both in a cyclical industry that is at trough. These companies operate in slightly different niches within that industry, such that company A is gaining market share and generates attractive free cash flow, even at trough. The value of the business for company A increases by 8 to 10% from that market share growth and from that cash flow generation.

While company B grows in line with the industry and it’s break even. Where growth in value is only slightly positive. If these two companies are at a similar discount to intrinsic value, after a year, if the level of discount is unchanged, shares in company A would have outperformed because of better growth in business value. If shares in these companies are unchanged after a year, company A is now trading at a more attractive valuation than company B. We assume over time that stocks trade towards their business value. And so, we can be patient with company A, because we know that the coiled spring is loaded up. With company B, the longer time passes, the lower our annual returns will be. We try to select investments where time arbitrage allows fundamental results. Not short-term sentimental volatility to generate positive investment returns.

PARKER: When we think about undervaluation, our starting point is a substantial discount to our estimate of intrinsic value. In our view, that intrinsic value is a distribution of outcomes. It's not a single point, so we spend a lot of time arriving at our best estimate of intrinsic value, but we spend just as much time thinking about the shape of that distribution and the downside risk of an investment. We like to think about it as buying a business for cents on the dollar. If we have one business with a strong competitive position, stable demand and low financial leverage, that creates a narrow range of outcomes that we would think of as a high-quality dollar. And to us, $0.70 on the dollar would constitute a sufficient discount. A different company that's more cyclical, not as well positioned and perhaps has some financial leverage, will have a wider range of potential outcomes. We think of that as lower quality dollar. And as a result, we're going to demand a much larger discount to invest in those shares. We might think of buying that for $0.50 on the dollar. What we're really seeking is a highly asymmetric risk reward. Again, the idea of heads we win, tails we don't lose that much.

We believe that our investment process can generate alpha across a variety of different market environments, given our company specific approach. Our process is not predicated on any particular economic environment or any particular market environment. That's also one of the great features of the small-cap asset class. There are always interesting, undiscovered undervalued companies to invest in.

That said, small-caps in general tend to have a greater degree of economic sensitivity than other capitalization ranges, and thus the businesses and often the shares tend to perform well during periods of solid economic growth.

Many people believe that is just at the trough, though. Small-caps often performed very well at upward turning points and cycles. But a period of robust growth in general is also typically very conducive to favorable reforms for small-cap equities.

Given the risk reward aspect of our investment philosophy and process, we would expect TSCV to perform well following periods when valuation dispersions have become significantly wider than normal due to excessive fear and uncertainty, or following periods of unwarranted optimism and speculation.

CHAN: Small-cap exposure is a core aspect of an asset allocation framework. We believe TSCV would be an attractive option for investors who want to maintain or increase that exposure while doing so, in a manner that mitigates excessive volatility, given the risk management framework of our fund.

TSCV would also be an attractive option for investors seeking to capitalize on especially wide valuation dispersions between small-cap and large-cap equities. As value investors, we believe that valuations at point of entry greatly influences future returns. Furthermore, small- caps can benefit greatly from declining inflation and federal rate cuts, or when regulation and policy changes create new business opportunities that small-cap companies can leverage agilely, leading to impactful changes in their profitability. These impacts might not be priced accurately by the markets initially, creating opportunities for value investors with a sound risk management framework.