What’s the Fund’s goal, and how is it managed?
The goal of the Fund is to deliver consistent excess returns, and importantly, without taking excessive risk.
We define value as undervalued companies with higher improving economic returns. So, this differs from some other value managers who might [prefer to] devalue and only buy things that are cheap without caring about the quality of the companies.
We are bottom-up stock pickers, and we don't make market calls. We strive to outperform regardless of if the market goes up or down by rigorously vetting the companies that we own.
We don't invest based on themes, but if there is one, we like “boring.” We don't know the headline stocks, things like Tesla, crypto – that's not our area of strength. We tend to avoid it. It's crowded. We try to own high-quality companies that are neglected or undervalued.
We look for stocks with an asymmetric reward/risk profile. What this means is, first we start with the downside. Can we quantify the downside and is it limited? Usually, we define that as less than 20% downside. On the upside, we look for multiple times of that – call it three times more upside – to get to the asymmetric reward/risk ratio.
As investors, we rely a lot on history. We go back and ask, “Where did these stocks trade to in a weak environment? Or, when there are issues, what's a good support level?” So, we run through multiple scenarios to figure out the downside, but one key there is that it has to be quantifiable. There are companies, for example, insurance companies – AIG, during the Great Financial Crisis; Lehman Brothers – where you just didn't have enough information to quantify that downside.
In terms of upside, we try to model out our thesis. So, if our thesis is that “we believe this will happen based on our research,” then we model it out. We project, we forecast. “In our view, [here’s] what the earnings power or free cash flow power of this company is, and what [people would] pay for that kind of earnings power.” And the key there is that we use our own proprietary research and modeling, and we're not relying on consensus or sell side for that.
Describe recent performance & headwinds in this area.
In terms of how the market has done, value has beaten growth in the last two years, and that's after a ten-year plus period where growth has beaten value. We believe that it will continue. In an environment where there's high inflation and high interest rates, that tends to benefit more of the value sectors, such as financials, materials and energy. Financials – with the banks, when interest rates are high, they make more of a profit margin. Energy and materials are commodity sectors, so they tend to get more revenues when inflation is higher.
One thing that we really like to ask is, “How is this cycle different?” This cycle is different from the last 20 or 30 years because inflation feels sticky this time around. And why is that? One, the labor market is tight. The labor force growth is much lower than previous years. There are fewer workers, so that leads to higher wages. We have a lot of headwinds from deglobalization, whereas before, we had globalization with international trade and loosening of emerging markets. We’re moving the other way between the China conflict and the Russia conflict. China and Russia are both huge suppliers of that market, whether it's components, energy or materials.
We also have high commodity inflation because of fiscal spending on the energy transition and where we're spending on renewables. But the price has to be high enough to stimulate the investment. Lastly, China's new focus on improving pollution and standard of living there also means that we're going to have higher inflation.
Where is the potential for mid-cap value stocks?
These growth-versus-value cycles tend to be long. They tend to be – at least the last few we've had – ten plus years long. We’re in the third year of value outperforming growth. So, we feel like there's a good chance that we're early into this value outperformance cycle. The reason for this is that the macro environment is more supportive of the value sectors. Higher inflation and higher interest rates benefit more of the value sectors. On the other hand, when interest rates are high, it hurts expensive companies that don’t generate a lot of free cash flow.
Regarding mid caps, we really like this box. We think mid-caps have better risk profile than small caps. Mid caps tend to be more established. In fact, you can find market leaders that are mid caps in many industries, more niche industries.
As compared to large caps, we also like mid caps because the fishing pond is larger. There are more companies to look for ideas. There's also less market efficiency, so, more potential for us to outperform picking stocks in the mid-cap world.
When it comes to macro, we think of macro factors more from a risk management perspective. We don't try to win by getting the macro picture right. When we look at macro factors, we're trying to neutralize this and make sure we don't have any unintended bets, as in, the portfolio is not constructed because we have a bullish view of the market or a bearish view of the market.
What this means is that we really try to take all our risks in the stock selection bucket and win by picking stocks.
How did the Fund succeed during the pandemic years?
Performance has been good. In 2020, when the fund was put together and launched, we obviously didn't predict Covid. I remember at the time, economists were calling for a recession within two to three years. So, ‘22, ‘23. And no one predicted Covid, obviously.
But, again, back to what we do is, we always ask the question, “Where do we think we are in the cycle?” At the time, given that we were in the tenth year of a long economic cycle, it just felt like the right thing to [do was to position] a little bit more defensive and own later-cycle names. We really benefitted from that in the sharp correction in March/April of 2020. At the bottom, we were actually able to follow our valuation process and noticed that a lot of the cyclical companies were trading at excessive discounts. So, we were able to pivot to those companies that we were stocking. So, we benefitted on the way down, pivoted to more cyclical, early-cycle companies and benefitted on the way up.
We looked at a company called Sysco, the food distributor – you've seen the trucks out delivering food to restaurants. The question we asked ourselves was, “How long could restaurants be completely shut and for Sysco to survive and not have liquidity issues?” And the answer, after the analysis, was two and a half years. Then our decision at the time was, “Do we believe Covid is going to lead to restaurants being closed for more than two and a half years?” We believed that it wouldn't. We own the stock and has been a fantastic winner for us.
In 2021, we had a great year again. We outperformed in eight out of 11 sectors. It was the first year that value outperformed growth and we particularly benefitted in the tech sector. So, names like Jabil, which is an EMS – electronic manufacturing service company. They're not the Teslas of the world; they're not the Apples of the world. But they make the items for them. They've pivoted to become a high margin, high free cash flow company as the industry has consolidated and was a big winner for us.
In 2022, we had another good year. We outperformed in nine out of 11 sectors. The topic in ’22, or the headwind in ‘22, was obviously inflation. So, we made sure that we owned companies that had high, strong pricing power to deal with the environment.
AGCO is a good example. AGCO makes ag [or agricultural] equipment. There's been a lot of innovation in that space, such as precision ag. These technologies help farmers to be more productive. They have to hire fewer people, which helps with labor costs as well. So, AGCO had tremendous pricing power during the downturn.
Another example would be Dollar Tree. Dollar Tree during this period went away from their legacy of everything priced at a dollar. So, we call it “debucked,” since they raised their price by $0.25, up to everything at $1.25. I don't know if consumers noticed it or not, but as an analyst, $0.25 is 25% price increase. That's fabulous pricing power for them in an inflationary environment.
That was a lot of details, but the overall theme of our outperformance is that stock selection drove all of our outperformance in all three years.
What is your sell strategy?
Our sell strategy is similar to our buy strategy. We analyze valuation, operations and sentiment. Whenever we become uncomfortable with any of the baskets, we would trim a little bit. Valuation: as the stock gets expensive, we would trim. Operating: if the company is not tracking to the operating fundamentals, we would trim. And then sentiment: when our thesis become more consensus, we would also trim a little bit.
Importantly, we also keep thesis on all the stocks we own and we sell whenever we believe the thesis has been broken.
What makes Thrivent different?
We're big believers in active management. Active management really allows us to concentrate our portfolio into our best ideas. And unlike passive products, we don't have to own the bad companies; we only own our best ideas.
Active management also allows us to be a lot more nimble and flexible. For example, cyclical investing is a big part of value investing. So, when we're at the trough, we're nimble enough to go and buy the companies that will benefit from the recovery.
We're definitely not momentum investors and we try to be non-consensus; when the market zigs, we tend to zag. I'll give you a good example of that. Last year, as interest rates were rising, we saw a lot of high-quality companies that might have not as good balance sheets – poor balance sheets. Maybe they made an acquisition, which would have temporarily levered up their balance sheet. They’d be really penalized by the market because of the fear of interest expense, or how much more expensive interest expense would be for them. So, as these companies got overly discounted, we actually thought this was an opportunity, so we started buying into these companies that were more levered but were high-quality companies.
At Thrivent, we have a strong team of analysts. Specifically, for the small- and mid-cap PM teams, we have 15 analysts supporting the different funds. We collaborate closely with the analyst team, from idea generation to the due diligence process. Because [of our collaboration,] we don't need the analysts to write 20-page primer reports. We’re on the calls together asking our questions. So, by the time we meet [to discuss a company, we go] through our proprietary financial model together and figure out what we're forecasting, what we're valuing the company to be, and the risk/reward ratio of the company. But, [by that time,] we're really at the conclusion phase [and we’re asking,] “What do we all believe in after all this work?”
What has shaped your career and investment philosophy?
I really learned a lot going through the Dot Com Crash and the Great Financial Crisis. Given that [the former happened] when I started my career, and [the latter came at] core of my career, it's really shaped me and made me a better investor. Going through the Dot Com Crash, with the Enrons and the WorldComs, it made me really understand that management can lie. We really have to roll up our sleeves, do our own analysis, check their books, and make sure that these are companies that we can invest in. The Great Financial Crisis was similar. There were a lot of people who didn't believe we had a crisis and didn't believe that banks were going to fail. So, both experiences taught me to be skeptical, to do our own analysis, and to be critical.
We're a basketball family. I coach AAU basketball and I still play a couple of times a week. My kids play as well. I really appreciate the sport of basketball because it teaches you to be a team player. In high school, I was a backup point guard. When I asked my coach, “What is my role on the team?” He said, “Your role is to push the starters during scrimmages and practice.” He didn't say “You could be a starter;” he said “Your role is to accept that you have to make your teammates better.” And at Thrivent, we have a lot of strong investment people, and I feel like every day we're pushing each other to be better.
