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Mid Caps with Improving Fundamentals and Sentiment
BMO Mid-Cap Value Fund
Interview with: Thomas Lettenberger

Author: Ticker Magazine
Last Update: Jul 10, 10:07 AM ET
Although the mid-cap universe appears to be more concentrated compared to other segments of the market, sifting through this pool of 700 stocks calls for a well-defined process and clear objectives. Thomas Lettenberger, portfolio manager of the BMO Mid-Cap Value Fund, relies on a data-driven investment process centered on company fundamentals, investor sentiment, and a comprehensive risk framework to build a portfolio with the potential to outperform over a full market cycle.

ďWe look for improvement in fundamentals. We are not going to buy a stock hoping for a catalyst to happen; instead, we make investment decisions based on visible improvements in the company financials.Ē
Q: What is the history of the fund?

A: The BMO Mid Cap Value Fund was launched in 1997, and our team, which has been managing institutional Mid-Cap Value assets since 2000, took charge of the fund in October 2016. The fund currently has approximately $210 million in assets.

Our investable universe consists of the 700 names in the Russell Mid-Cap Value Index. The companies that fall into the mid-cap value category range from about $3 billion up to close to $30 billion.

Q: What core principles guide your investment philosophy?

A: We have two core beliefs. First, that company fundamentals ultimately determine stock prices; and, therefore, companies that have improving fundamentals, attractive relative valuations, and improving investor sentiment are most likely to outperform over any market cycle.

And second, that a systematic evaluation of company fundamentals is the most effective means of consistently outperforming the market. By combining both fundamental and quantitative analysis, we believe that we are positioned to achieve consistent performance over time.

Q: What is your investment process?

A: Our investment process is a bottom-up approach with the goal of maximizing returns while controlling portfolio risk. Our process employs three primary inputs: return forecasts, risk forecasts, and an evaluation of current market conditions.

The first input requires forecasting returns for every company in our investable universe. We accomplish this by utilizing a proprietary model that captures a diversified set of investment characteristics for each company. The model analyzes companies by considering three broad buckets of characteristics.

The first bucket analyzes the fundamental attractiveness of each company. The second bucket analyzes the relative valuation of each company. The third bucket analyzes the companies based on investor sentiment and ownership characteristics.

The second input is a comprehensive risk assessment, both at the individual name level and, more importantly, at the portfolio level. We do this by utilizing five different risk models, as well as performing a fundamental assessment of every company in the portfolio.

The third input is an assessment of current market conditions. We determine that by using a proprietary tool called Market Monitor to identify unusual market relationships and identify any portfolio exposures that needs to be adjusted.

There are approximately 20 total factors in our model that each measures a different characteristic of a company, from which we create a ranking. The model is designed to look ahead 12-18 months. We have found that the top quintile has a hit rate in the 55% plus range. On average, the companies that rank well in our model are going to outperform and meet our objective of outperforming the benchmark by 200 to 300 basis points a year over a full market cycle.

Q: What role do catalysts play in your investment process?

A: We donít look specifically at catalysts because we think that we capture that within our modeling process. We look for improvement in fundamentals. We are not going to buy a stock hoping for a catalyst to happen; instead, we make investment decisions based on visible improvements in the company financials.

Moreover, our modeling process looks at investor sentiment, which includes price momentum. So we try to buy a stock as it starts to go up as opposed to a stock thatís been going down for a long time. We look for stocks that have either lower levels of short interest or companies where the amount of short interest is declining.

Q: How would you describe your research process?

A: We use a combination of quantitative and fundamental metrics, rather than doing a deep due diligence into each company. Our fundamental analysis involves looking through regulatory filings, utilizing Wall Street research, and occasionally talking to the company management. This allows us to validate our model results and confirm that what our model finds attractive makes sense. We are acutely aware that our stock ranking models arenít perfect and we need to look to see if there is something about a company that we are missing.

We scrutinize SEC documents and analyst reports to find things like large customer concentration, regulatory hurdles, or other risk that the company is facing. For instance, if we are looking at a pharmaceutical company and they have a drug coming off patent in the next 18 months, we try to determine how it will affect their sales and earnings.

Q: How is your portfolio constructed?

A: The portfolio contains between 60 and 80 names at any one time. Generally, up to 25% of the names in our 700-name investment universe rank as potential buy candidates. If they drop below the 35% rank level, thatís where weíll be looking for a replacement.

Our investment objective is to maximize return at an acceptable level of risk. To manage risk, we maintain individual holding maximums of 3%, but most of the names in the portfolio are under 2%. We also have constraints on the overall portfolio such as sector weightings of plus or minus 5%, relative to the benchmark, and industry weighting of plus or minus 3%.

We use five different risk models and our objective is to measure our portfolio risk exposures in many ways. In addition, we diversify our risk exposure to make sure we are not getting too much exposure to any one risk factor.

Q: What is your portfolio turnover range?

A: Our portfolio turnover ranges from 50% to 70%. We trade roughly once a month and when we decide to add a name we are normally planning to hold it 12 to 18 months.

The way our model is constructed limits the rate of changes in the rankings. We donít see big, quick changes. So, a company that ranked well yesterday will continue to rank well unless there is a significant change to the fundamentals of the company.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc