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MARKET UPDATE

Mining the middle ground: What’s driving growth in the mid-cap market?

03/12/2021

By Gene Walden, Senior Finance Editor | 03/12/2021

For investors, the mid-cap sector can get lost in the shuffle between the alluring promise of small-cap stocks and the familiar market leaders of the large-cap sector.

But the mid-cap market – which encompasses stocks in the range of about $7 billion to $35 billion in market cap – offers a world of opportunity for investors looking for long-term growth potential with a bit more stability than many of the stocks of the small-cap universe.

“The mid-cap market offers more established business models, more established management teams, and a little less risk versus small cap stocks,” explained Brian Flanagan, senior portfolio manager of Thrivent Mid Cap Stock Fund (TMSIX). “And it typically offers better growth opportunities versus large cap stocks.”

While the large cap sector has been leading the way in terms of performance recently – particularly the technology area – Flanagan points out that “over the long-term, mid-caps have traditionally offered better growth than the large caps.”

Growth trends in the mid-cap market

Although the mid-cap universe has trailed the blue chips in recent years, as the economy unwinds from the pandemic, Flanagan sees a number of factors that could favor the growth of mid-cap stocks:

  • Monetary stimulus. “The Federal Reserve is committed to keeping interest rates low until they are above their inflation target for a period of time and to see the economy at full employment.”
  • The fiscal stimulus packages in 2020 and 2021. Congress has injected trillions of dollars into the economy through its recent stimulus plans. If an infrastructure package is approved in the near future, that could contribute further to economic growth.
  • Vaccine roll-out. The reopening of the economy should be a significant boost to the recovery.
  • Worldwide growth. “China has been the first to rebound with pretty significant growth, and that has helped a number of economies worldwide,” said Flanagan. As the pandemic continues to fade, economies around the world could see renewed growth.
  • Consumer balance sheets. “Typically, the consumer savings rate has been around 8%, but right now the savings rate is up at around 20%. With the next stimulus package, that could go above 25%.”

“If you add up all of these factors,” he added, “we should see strong growth going forward. That may be especially true in the cyclical sectors that have been struggling over the past few years and that have a fairly substantial weighting in the mid-cap space.”

What’s behind Thrivent Mid Cap Stock Fund’s industry-leading performance?

Thrivent Mid Cap Stock Fund – Class S (TMSIX)  was recently recognized as a Refinitiv Lipper Fund Awards 2021 winner for “Best Mid-Cap Core Funds Over 5- and 10-Years” (out of 245 and 170 funds, respectively, for the period ended November 30, 2020). (See: Our Achievements)

Flanagan attributes much of that success to three key factors – people, process and patience.

“Thrivent has an outstanding investment division with experience through many different market cycles and dynamics across industries,” said Flanagan, “The Fund management team – Brett Schweisow, Chad Miller and I – has the support of a 24-person fundamental  and quantitative research team with over 19 years of average experience.”

Their investment process focuses on adding value by investing in attractive companies at good valuations while controlling risk. “It begins with a quantitative screening process that identifies attractive companies that we should do the fundamental research on,” added Flanagan.  That research revolves around three main areas:

  1. Operating performance. “We’re looking for companies that can maintain a high return on invested capital or improve their return on invested capital through revenue growth, operating efficiencies, and capital management.”
  2. Valuation. The team determines an underlying value for each company in the portfolio through fundamental research, such as discounted cash flow analysis, free cash flow yield analysis, and the comparative analysis of the stock’s relative or normalized earnings multiple to the market (depending on the sector).
  3. Market sentiment. “We try to identify how our thesis on a company is different than the market’s. Some of the factors that we analyze are insider transactions and valuation spreads across the industries.”
Patience is the third key element of the overall strategy and, according to Flanagan, “probably the most important piece and maybe the hardest piece.” He added: “Underlying volatility in the market can cross up your rational decisions, which is why we need to be able to have patience with our process. That’s why we’re very fortunate to have a management team, board of directors, and shareholders who have the confidence in our process and our people to achieve that consistent long-term performance.”

Sell strategy

The Fund considers a number of factors in weighing when to sell or reduce a position:

  • When a company’s fundamental characteristics deviate from their thesis,
  • When the stock price exceeds the underlying value that they have set for the company,
  • When they need to control risk by selling or reducing positions to rebalance the portfolio,
  • When they find a better opportunity elsewhere. “That’s probably the least likely scenario,” said Flanagan, “but it happens.”

Risks of the mid-cap market

As with most investments, mid-cap stocks carry significant risks, such as macro risks, company risks, and competitive risks, according to Flanagan. “However, we typically see the most opportunity when valuation spreads are wide, investors are bearish, and the risks seem high. With a solid process, smart people and patience, those environments can offer significant opportunity to create long-term wealth.”

Active management can help in controlling risk, according to Flanagan. “Active management may have an advantage when stock correlations are low across the market and in an environment where more domestic assets are invested in passive index funds and ETFs. Currently, over 50% of domestic assets are invested in passive funds versus approximately 25% a decade ago.”

Stocks that are not in an index may fly under the radar, providing opportunities for active managers to buy those stocks at a good value relative to the market. “As correlations come down, and passive investments go up, that provides more opportunity for active managers.”

Opportunities in the mid-cap market

“With valuation spreads wider than normal, prodigious fiscal and monetary stimulus, strong consumer balance sheets, and growing worldwide economies, we see opportunities in the value portion of the market – primarily in financials, industrials and materials,” said Flanagan.

Policies being advocated by the current U.S. administration and other administrations around the world, such as infrastructure, renewable energy and electric vehicles continue to gain prevalence. Flanagan believes that should help boost the cyclical industries, such as industrials and materials, which have a strong presence in the mid-cap universe.

He is also strong on financial companies, which held up better than expected during the pandemic, and were able to keep credit losses below expectations. Among the Fund’s holdings in those areas are:

United Rentals (URI). As the world’s largest equipment rental business, United Rentals should benefit if infrastructure becomes a focus of the new administration.

Western Alliance (WAL). The banking firm has developed a unique business model that has led to solid loan growth, as well as other opportunities in the financial market.

Aptiv (APTV).  The auto-parts supplier has a strong foundation in electric and autonomous vehicles.

Nuance Communications (NUAN). This leading healthcare software provider specializes in conversational artificial intelligent platforms.

As the economy and the markets evolve, Flanagan believes the key to continued success is adaptability. “Change is constant. Through my career, the economic and investing landscape has constantly changed. When I was managing a tech fund in the 1990s, I thought I would never see anything crazier than that, and then the financial crisis happened, and now we’re living through a pandemic.

“So, what I’ve learned is that we have to be prepared for everything. We have to be constantly studying and learning, improving our skills, and adapting our strategy when necessary in order to continue to provide consistent, long-term returns.”

See more on Thrivent Mid Cap Stock Fund

Gene Walden
Senior Finance Editor

Related insights

Thrivent Mid Cap Stock Fund: Dynamic approach, consistent performance



Past performance is not necessarily indicative of future results.

All information and representations herein are as of 03/12/2021, unless otherwise noted.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

This article refers to specific securities which Thrivent Mid-Cap Stock Fund owns. A complete listing of the holdings for the Funds is available on thriventfunds.com

The Refinitiv Lipper Fund Awards, granted annually, highlight funds and fund companies that have excelled in delivering consistently strong risk-adjusted performance relative to their peers.

The Refinitiv Lipper Fund Awards are based on the Lipper Leader for Consistent Return rating, which is a risk-adjusted performance measure calculated over 36, 60 and 120 months. The fund with the highest Lipper Leader for Consistent Return (Effective Return) value in each eligible classification wins the Refinitiv Lipper Fund Award. For more information, see lipperfundawards.com. Although Refinitiv Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Refinitiv Lipper.

Refinitiv Lipper Fund Awards, ©2021 Refinitiv. All rights reserved. Used under license.

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