Q:  What are the core beliefs behind your style of money management?

A: We established the Thrivent Diversified Income Trust Fund with the idea to respond to the growing need for income streams that aren’t just static but have the probability of growth. With this fund we aim to fulfill three needs of our shareholders, namely, to provide income, downside principal protection, and long-term capital appreciation.

We take a long-term view of about 20 years when we examine the probability for growth of capital because we consider the potential long-term needs for pre-retirees and retirees. We also run a high-yield mutual fund for investors who need pure income, but we recognize that the high-yield market alone cannot address the problem of longterm retirement income. To achieve that goal you need not only a pure credit portfolio, but also equity exposure.

So we studied a number of different asset classes and created a mix that we believe can satisfy these three goals. This mix is the result of our long-term quantitative work and our experience both in the mutual fund world and in the insurance business. These asset classes are high-yield bonds, which are the core for income generation, high dividend-paying stocks, and REITs, which is an asset class that has been growing dramatically over the past 10 years.

The overall philosophy is to use multiple sectors in the financial markets to generate income and long-term growth of the principal. We employ a multi-manager strategy (myself plus Paul Ocenasek, Kevin Brimmer and David Spangler) to focus on the individual sectors and drill down into the specifics of these three areas to find value.

Q:  How do you translate that philosophy into an investment strategy and process?

A: The process begins with the allocation of the portfolio in the three categories – high-yield bonds, REITs, and high dividendpaying stocks. The next step is allocating money to individual managers with expertise in the various sectors that we invest in, taking into account the expected returns of the various asset classes. This is a multi-manager portfolio and, similarly to our insurance accounts, we allocate capital to different managers to optimize the performance within their sectors.

The work of our quantitative research group generates a model portfolio that should achieve the three goals over a long period of time. But at any given point in time, we may tilt away from that static model by as much as 10%. For example, our model allocation to high-yield bonds is about 45%, but because we consider high-yield bonds to be somewhat rich right now, our exposure is down to about 35%.

We may use other sectors, such as convertible bonds and preferred stocks, for a portion of the portfolio when we believe that the expected returns in those areas are more attractive. That’s how we assess relative value - we start with our model allocation and then we put an overlay of the expected returns relative to risk. Comparing the yields of the various sectors remains a key part of the process, and to make our allocations, we compare the dividend yields of certain parts of the equity market with a high-yield bond, for example.

We may use our convertible bond capability when we want to have more downside protection in a certain situation. Part of our strategy is always to assess the value between the different parts of the capital structure that we can buy within a specific name. We might also have exposure to Master Limited Partnerships, which represent a sub-sector in the high dividend-paying stock arena. Another instrument that we use is preferred stocks.

Q:  Would you explain your strategy for each specific asset class?

A: In the high-yield sector, the decisionmaking process involves constant analysis of current yield for various quality sectors relative to their historical yield. About half of the portfolio is currently allocated to BBrated bonds because with spreads tight, you are not paid well for the risk in CCCrated bonds, which are like quasi-equities. In investment grade bonds, we consider a whole range of securities. Our long-term static allocation to high-grade bonds is only 5%, but right now our exposure is about 10% because we believe that higher-quality bonds are better value. To ensure that we generate enough yield, we may also invest in hybrid and mortgage-backed securities. The new hybrid securities are almost like preferred stocks. They fit well with the portfolio and provide diversification while generating higher yields. The main difference is that they are very low in the capital structure, much like a deeply subordinated bond.

Our equity exposure is driven almost entirely by top-down quantitative screens on high dividend-paying stocks. Different from many bottom-up equity portfolios, we use a fundamental review on the companies only after we screen them quantitatively. Instead, we use multi-factor screens to find the highest dividend-paying opportunities. Screening criteria include a market cap of at least $1 billion and a payout ratio of no more than 95%. Basically, we look for companies that don’t pay more than they earn and that exhibit dividend growth over time. The other screens aim to ensure that the portfolio has growth elements, so we screen for growth in sales and earnings to avoid being stuck with companies with negative growth rates.

For the high dividend paying stock portfolio, we start by screening The Mergent Dividend Achievers Index. This index is made up of companies with significantly higher dividend yields than the S&P 500. For example, right now our average yield in highdividend paying stocks is about 4%, while in the S&P 500, it is about 1.7%.

On the REIT side, we also run screens for dividend-paying capability, but with a different twist. We are aware of the sectors within the REIT universe, and we make sure to achieve balance between apartments, office, and retail properties. We consider the long-term return and the volatility of the market, which has grown rapidly in a relatively short period of time. Right now the REIT market looks fully valued to us, and we maintain half the weighting of our model allocation. We’re never going to exit entirely the REIT market but the near-term analysis doesn’t support a large exposure.

The REIT part of the portfolio has a dividend yield of about 5% and has been quite successful in the past year. Those stocks attract private equity investors because they generate a lot of excess cash. We have been fortunate to have big positions in companies that have been bought out, although we aren’t specifically looking for buyouts. However, our screening mechanisms might be similar to the screening mechanisms of some of the buyout firms.

Q:  What would your strategy be for companies like General Motors, which may be paying high dividends despite the fact that its core business is in trouble?

A: GM wouldn’t have passed the screens because it is not growing and its dividend payout ratio is over 95%. That would be enough to eliminate that stock. Although our process is quantitatively driven, we have a research group that ensures that the names pass certain fundamental tests as well.

Q:  Would you illustrate your process with some examples in each asset class?

A: A good example on the bond side would be Rogers Communications, the Canadian company. We found the industry to be compelling, with attractive fundamentals, and good valuation. We found the BB-rated credit of Rogers to fit our portfolio due to its compelling yield for the lower risk credit profile of the company. There was also significant potential as an upgrade candidate.