Putting The Pieces Together of a Small-Mid Cap ESG ETF

A Comprehensive ESG Approach

TSME is designed to offer exposure to small and mid-sized companies with attractive fundamentals that have committed to sustainable business practices. It extends beyond traditional ETFs by incorporating a comprehensive ESG analysis into the fundamental research process to also prioritize small and mid-cap companies with a sustainable impact.

The portfolio selection for TSME is not merely dependent on a company's alignment with ESG standards but involves an in-depth, case-by-case analysis of each potential holding. Matt Finn, Head of Equities, and Chad Miller, Senior Portfolio Manager, strive for a holistic approach, ensuring the ETF comprises top-performing companies that address their material ESG issues effectively.

In managing the ETF, the integration of ESG standards adds a distinct perspective to the selection process. The criteria for stock analysis may become more complex, particularly in the small and mid-cap sectors where ESG research data may not be as extensive.

However, rather than limiting opportunities, this approach aims to identify investments that align with both financial objectives and sustainability considerations. This can lead to different investment choices compared to traditional SMID cap funds.

The Role of Active Management

Active management is at the heart of TSME, which Miller believes offers a significant advantage over passive ESG funds. Active management allows the Fund’s team to understand each holding from a complete 360-degree perspective, engaging in deep and meaningful conversations with the companies, beyond what the ESG reporting services reveal and analyst coverage of small and mid-caps provides.

TSME leverages the considerable experience and profound expertise of its investment team to curate a portfolio that encompasses approximately 60 small- and medium-sized stocks with a blend of both growth and value styles. These stocks, beyond their attractive fundamentals, must also demonstrate a commitment to ESG initiatives and sustainable business practices.

This active management approach positions the Fund to capitalize on market inefficiencies in the lesser covered small and mid-cap market segments. The team behind TSME can identify undervalued companies that are poised for growth and that are also meeting or exceeding ESG expectations. Active management gives TSME the flexibility to adjust holdings based on evolving ESG standards and corporate actions.

ESG Investing and TSME's Approach

The underlying philosophy of TSME's investment strategy is rooted in the belief that ESG considerations are integral to understanding both the risks and opportunities that may be material to companies' financial performance.

By focusing on ESG factors, TSME aims to pinpoint companies with proactive management teams that are capable of anticipating and adapting to shifts in technology, regulation, and market preferences. Such companies are seen as less likely to be blindsided by new environmental laws, social movements, or governance issues.

The approach of TSME isn't about social justice or political correctness; it's about recognizing well-managed, long-term sustainable companies. Those prioritizing environmental, social, and governance factors are considered to be more resilient and well-positioned to face risks and challenges.

ESG investing opens doors to new investment avenues that traditional financial analysis might overlook, such as innovators in renewable energy or companies with inclusive workplaces, potentially giving them a competitive edge.

Additionally, TSME's ESG strategy doesn't compromise on diversification. The investment universe is vast, with thousands of companies around the world possessing strong ESG credentials across various sectors. The portfolio can be as diverse, if not more so, than a non-ESG one, with the added consideration of long-term sustainability.

By embracing these principles, "TSME aims to align its financial objectives with broader societal needs and emerging trends, aiming to create a portfolio that reflects not just the current market landscape but also the evolving global context."

ESG and Portfolio Performance

The relationship between ESG investing and portfolio performance has been a topic of considerable interest and debate. Some argue that there might be a trade-off between focusing on ESG issues and achieving optimal financial performance. Others posit that ESG factors are a vital aspect of corporate performance and risk management, and therefore, can contribute to superior returns.

TSME adheres to the latter view, which sees ESG investing not as a sacrifice of returns but as a method of risk mitigation and potential performance enhancement. By identifying companies that not only have the potential to deliver robust financial performance but also demonstrate strong ESG practices, the Fund can create a portfolio that is positioned to deliver sustainable returns.

Miller suggests that the incorporation of ESG factors in building a portfolio may contribute to strong investment performance. This performance is due to the significant attention ESG topics receive from executives and boards of directors in shaping company strategies for the upcoming decade.

Moreover, there's a growing recognition that companies with strong ESG practices may have a strategic edge. These companies often operate more efficiently, innovate more effectively, and face fewer regulatory and legal issues, all of which can contribute to better financial performance.

Thrivent believes that companies proficient at serving their primary stakeholders, such as employees, are more likely to attain long-term success, thus offering attractive return potential. The thesis is that an in-depth analysis of material ESG topics offers crucial insights into a company's long-term viability and financial outcomes.

To substantiate this, evidence demonstrates that companies that prioritize their employees yield a 2% to 2.7% greater excess return annually [1]. Furthermore, there's a notable 3-8% annualized alpha difference between companies that exhibit strong performance on material sustainability issues versus those that do not [2]. Sustainability practices, in particular, have been shown to lower the cost of capital, with 80% of studies confirming this finding for companies with robust sustainability practices [3].

TSME ETF: Conclusion

TSME is a purposeful blending of small and mid-cap assets in an ESG framework, managed by the experienced team at Thrivent. This combination offers a unique investment opportunity, prioritizing both sustainable impact and competitive returns.

To explore more about TSME and Thrivent, visit the homepages for the ETF and Thrivent Asset Management. Want more information from Thrivent? Sign up for ETF updates here.

References:

[1] “Employee Satisfaction and Long-run Stock Returns,” Financial Analysis Journal, September 30, 2021

[2] “Corporate Sustainability: First Evidence on Materiality,” Harvard Business School Working Paper, March 2015.

[3] “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” Whitepaper, March 15, 2015, Smith School of Enterprise and the Environment.

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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.

Although diversification can help reduce market risk, it does not eliminate it and it does not assure a profit or protect against loss in a declining market.

The ETF is newly formed and does not have any operating history. Small and medium-sized companies often have greater price volatility, lower trading volume, and less liquidity than larger, more established companies. The ETF’s value is influenced by a number of factors, including the performance of the broader market, and risks specific to the Fund’s asset classes, investment styles, and issuers. Markets may also be impacted by domestic or global events, including public health threats, terrorism, natural disasters or similar events. ESG strategies may result in investment returns that may be lower than if decisions were based solely on investment considerations. Because ESG criteria exclude certain securities/products for non-financial reasons, investors may forego some market opportunities available to those who do not use these criteria. ETFs trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF’s net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. The Adviser’s assessment of investments and ESG considerations may prove incorrect, resulting in losses, poor performance, or failure to achieve ESG objectives. The Adviser is also subject to actual or potential conflicts of interest. These and other risks are described in the prospectus.

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