Q1. Where is the potential in large-cap value stocks?
First, I just want to define what value stocks are. Some people talk about value stocks, they understand that the benchmarks in value have more financial, industrials, energy, materials, and real estate in them.
Value has got a tough reputation over the last ten years because growth has performed really well. The Russell 1000 Growth® index has outperformed the Russell 1000 Value® index from the Great Financial Crisis of 2008 until the Covid recession by about 6% per year. So, everyone loves the growth managers. Growth has done really well. But what they forget is the cycle before from the Dot Com recession to the Great Financial Crisis – or, 2001 to 2008 – Russell 1000 Value outperformed growth by 5%. So, almost a similar amount.
Back in 2001 you had the Dot Com recession. Remember, those were the excesses of tech. It took ten years for the valuations to catch up with the stock prices. But at the same time, you had very strong global economic growth. China was growing, interest rates were strong, but there were some signs of inflation. Value – financials, industrials, energy, materials – do well with good global economic growth and a little bit of inflation. [Value stocks] did well at that time, but it also ended up in a lot of excesses.
Towards the end of that economic era in 2008, we were lending and had too much debt and it led to the Great Financial Crisis. And what happened there is that those companies, like financials, got hit hard and they had increased regulation. So, over the last ten years, growth has done really well because of the economic growth. China cooled off, we had increased regulations here in the United States, and we really had very little economic growth last cycle, or low growth. Interest rates help growth stocks because growth stocks have a very good cash flow and long term.
So, where are we now? Since the Covid low two years ago, or the Covid recession low, the Russell 1000 Value index has beat the Russell 1000 Growth index by 12%, or 6% per year. Why was that? When I talk about spreads, that's the high value companies and the low value companies. Spreads widened out to a level that was not sustainable, just because people were fearful of going into recession. So, those spreads have come down. Value stocks have done well.
Who's going to lead coming out of this? It really depends on economic growth. It's not the Great Financial Recession, right? Companies are in excellent health. Consumers are in very good shape. So, it doesn't look like the excesses of the Great Financial Crisis. And what leads from here is we really need to see strong, long-term economic growth. But at this point, everybody looks back at the last cycle and say, "well, growth has been so good. I've got to own growth." I think, going forward, you need a more balanced approach, and I would have value as part of my portfolio.
Q2. What’s driven the Fund’s performance recently?
Value has done really well in the last two years, in the short term. And that's going to help Thrivent's Large Cap Value Fund, right? And we did it all through good stock selection. I really want to drive that point home.
Every sector had good stock selection except for Health Care over that time period. And none of the returns were really [due to] a big sector bet; we didn't have a very high risk bet on. The portfolio beta was very close to our peer groups – meaning, we looked pretty close to the benchmark. However, we put up very good returns relative to it. So, what that's telling you is that you did it through stock selection, right? It looked a lot like the index, but the stocks you picked did very well.
Q3. What’s your investment strategy and process?
We call it a return-focused process. The premise is, good return invested companies deserve higher valuations. So, if you look at that chart, you'll see value on [the vertical] axis, returns on the [horizontal] axis.
A lot of investors invest in that [flat, horizontal] dotted line across, where they'll just buy stocks that are under a certain value. We believe that, if you have good returns on the lower axis, you deserve a higher valuation. So, our investment universe is under that line [sloping upward from left to right]. We basically say, “hey, if you're not pricing your returns correctly, you should if you have a higher returns; you deserve a higher valuation.”
What's really important here to understand: it's not current returns. It's returns expectation in the future, what's built into the stocks. If investors expect really good returns and the value is already in there, there's no opportunity. But if a company has very good future returns and people aren't expecting it, that's where it provides opportunity for us.
Now, how do you put that into execution? We break down returns by the formula that goes into it, which is sales to capital, and NOPAT (net operating profit after tax) to sales or margin. So, when you look at returns in the sales to capital, growth guys will just look at the sales side of it. They just look at the TAM (total addressable market), how big the market can be. We care about that. But we care about the capital that is actually being put in to generate that sale. We look for the sales turnover. We look at both sales and capital. And NOPAT to sales is margin. We're always looking at margin because this is where we feel like companies control their own destiny sometimes, or where things can change the most.
How do we implement that with our analysts? We have very experienced analysts here and they have their own framework and process. And each analyst is an expert in their own industries.
Operating performance is 90% of what we ask the analysts to [look at]. They’re basically ranking their companies on group-specific operating fundamentals. So, they have industry frameworks. What they display is the most important factors to time versus stock performance. Then they do the qualitative assessment of changes in the industry or the company. What we want them to do is a detailed, fundamental analysis of that, but also to put it into a financial statement so we can look out two to three years in a normal period and understand where those returns are going. So, that's ranking their companies on operating performance.
And then on valuation, what we're looking for is, can they demonstrate what returns are priced into that stock? Can they look out and show us, [for example,] returns of this company are very good, but the valuation is low.
The last thing is the catalyst. What are the key performance indicators that are going to unlock value? Is it a product? Is it new management? Is it a cycle? What's going to unlock that value? So, we have to have a catalyst, because we're always usually buying something that has some controversy or low, poor sentiment. That's what we're looking for in stocks, and we apply this to every sector.
Q4. What’s your sell strategy?
Our sell discipline is basically that we sell when we're uncomfortable with valuation, we sell when we're uncomfortable with operating performance, and we sell the entire position when we're uncomfortable with both. That's the good sell.
Then we have what we call the bad sell. It's when a thesis is violated. To do this, you have to have a thesis well laid-out and written out and able to follow it; key performance indicators outside of quarterly reports. The worst is when you find your thesis is violated right on the quarter or right along with everybody else because it's immediately in the stocks. And even then, that's the hard part. That's where you say, "oh, great, I just missed it. And it's in the stock, and what am I going to do now?"
You have to have a discipline of selling when the thesis is broken. A clear way to do that is to have a clear thesis. A better way to do it is to understand it before anybody else does.
Q5. What risks are present in large-cap value?
The risk is the long-term outlook. If the economic long-term outlook of growth was too slow in people's eyes, or inflation was to remain high – we know inflation's probably not going back to what it looked like over the last ten years. And if it moderates a little bit, it's okay for value stocks, especially materials, energy, even financials.
What it is, it’s the global economic growth. If investors start to fear that the Fed is going to move too far or too long, that would be poor. If we think there's going to be greater regulations around the globe – we saw a little of that in China, right? They were coming down hard on their companies. Value stocks do need global economic growth. They don't generate a lot of their own growth. They need that to help them through their strategies. They're good at cutting costs, improving margins and even pricing, but they do need some economic growth. That's just the nature of financials, industrials, energy and materials.
Q6. How does inflation impact your approach?
As I mentioned, it's looking for those companies with pricing power. As we were coming out of the – I'll give you an example. Lamb Weston is a french fry company. Of course, people weren't eating fries. They weren't going out. Now, we were coming out of the cycle, so it's a very good, high return company.
The industry is – there's a few potato manufacturers, so they are usually able to pass on pricing, but they had one of the worst potato crops of all time. And they were having a hard time gaining through the shipping costs. However, when that was priced in, people were saying, "well, I don't think they're special anymore." That was a good time to own that stock because we knew from history that they could eventually get the pricing power through.
So, that's what we do along almost every sector when it comes to inflation. What names can price that in and what inflation is built into the outlook for many of those stocks?
Q7. What stepping stones led you to Thrivent?
When I did undergraduate, I studied finance at Notre Dame and I came out in the '90's recession. And that really impacted me on understanding what a recession means.
I went into trading futures, but what I didn't like is it was very technical, trend-following – I didn't know why things were working. You know, what was the underlying reasons, the value for it?
I went back to grad school. I went to Chicago Graduate School of Business, now known as Booth, and I put together a curriculum that I would be a fundamental analyst. I really studied hard on those tools that I used throughout my career. I did have a whole year of studying under Eugene Fama, a Nobel Prize winner. So, I kind of got my quant creds from studying under him. I got all my tools from MBA school, but I started my return-focused process at Brinson Partners.
After we had three kids and wanted to get out of Chicago, we moved back to my wife's hometown here up in Minnesota and I went to work for American Express. I had to pitch stocks to hedge funds, growth management, value managers. I was an analyst at the time, a tech analyst with a very value[-based] background. I got to return to those roots to work with Matt Finn. I came in a couple months after he took over the Value Fund.
Q8. Do you have a favorite book, quote, or motto?
I’ll give you my family motto. Raising five kids, we've always said, "every day you got to do something for your mind, your body and your spirit."
So, in this job, the mind is definitely taken, right? It's challenging every day. And I try to come up with something every day, that I learn [something] new about a company or new to my process; improvement.
Your body: you got to – I work out every day. You just have to keep your body strong. It helps to reduce the stress of your stressful job.
And the spirit: we always say, you can't do too much for the spirit. Every day I start with a morning prayer and a reflection – and then I spend some time in prayer because you have to have that good base. It does help in investing too. Of course, it helps in life in general because you're going to get things thrown at you. And if you have a good, balanced life, focused on what's important spiritually, then you can deal with that same thing in investing.
I've had many things that have just – you didn't know that Russia was going to invade Ukraine or that COVID-19 was going to come out of China. You have to react to these things and sometimes even your best laid plans get turned over.
Q9. What hobbies do you enjoy outside of work?
I love the outdoors. I had put a hockey rink in the backyard for the kids and I started playing hockey; never played in my life. And I absolutely love the outdoors and camping. I camp all four seasons. Matter of fact, I'll even go winter camping. I take everything to extremes. I’ll pull a sled out into the Boundary Waters and I'll set up a tent for five days. And I got a chance to combine those two last year.
And, matter of fact, there's an article that's in the Minnesota Department of Natural Resource magazine. It's the November issue. "Lure of the Wild Ice." We took hockey skates and we pulled sleds in about eight miles and we set up a tent because the ice was perfect. It's never perfect. It always snows right away or the wind blows. So, I got to combine my two favorite things. We played some hockey, did some ice fishing and some winter camping for a couple of nights in the Boundary Waters.
So that's my love of Minnesota. You got to go see this article. I'm more proud of this article than probably anything. Lure of the… there we are. That's me. My fund got written up in the Wall Street Journal, and I'm like, “forget that! Did you know I'm in the conservation magazine?”