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 led the way in terms of performance during the recent bull market – particularly the technology area – Flanagan points out that “over the long-term, mid-caps have traditionally offered better growth than the large caps.”
Thrivent Mid Cap Stock Fund – Class S (TMSIX) was recently named a Refinitiv Lipper Fund Awards 2023 winner for the category of “Best Mid-Cap Core Funds Over 10-Years” (out of 206 funds for the period ended November 30, 2022). (See: Our Achievements)
What’s behind the Thrivent Mid Cap Stock Fund’s industry-leading performance?
Flanagan attributes much of the success of the Fund 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 has the support of a deep fundamental and quantitative research team with an average of more than 20 years of 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:
- 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.”
- 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).
- 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 another 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
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.
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, followed by 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 potentially provide consistent, long-term returns.”
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