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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.


“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.”
Q: Do you have a price target when you sell a stock?

A: We do not use specific price targets to make sell decisions. We would normally continue to hold that stock until its relative ranking declines to a point where it’s no longer attractive and can be replaced by one that is more attractive.

We would also sell a stock if it violates our portfolio constraints, or for reasons of risk. In evaluating the portfolio, if we were facing an exposure larger than acceptable, a name with an undesirable risk exposure could be sold from the portfolio to provide a better balance.

Q: How do you define and manage risk?

A: We view risk management as being an important aspect of our overall strategy and risk assessment is integral to the construction of our portfolio.

As I mentioned earlier, we do use five different risk models. There are a variety factors that the models take into consideration, as well as different time periods. We want to make sure that the risk exposures that we choose to accept in our portfolio is where we have an informational advantage.

Our informational advantage is primarily through our modeling process. That is because we have the ability to look at all 700 companies in the universe on a daily basis and measure them all in the same way. The fundamental analysis that we do is as much a risk mitigation tool as it is an alpha generator. The area where we do not necessarily think that we have an informational advantage is in accessing beta. We can’t tell if the market is going to go up or down in the next year; therefore, we are not going to take a big bet on beta.

When the price of oil collapsed in late 2015, early 2016, energy companies were negatively impacted. But from our model, it was clear that certain banks in Texas and Oklahoma with big exposure to oil companies also traded in the same direction. We also saw that certain industrial companies linked to the energy complex sold off. Using our model, we were able to identify exposures in the portfolio that we might not have identified by using just a fundamental risk model.

Q: What lessons have you gleaned from the financial crisis?

A: We made some changes because of the financial crisis. In late 2009, we felt we needed to become more nimble and adaptive. Subsequently, we built a proprietary tool called Market Monitor. The tool utilizes over 40 years of data that allows us to identify unusual relationships within our mid cap universe.

We spent time trying to understand what was driving those relationships, whether those relationships were likely to revert to the mean; and more importantly, how our portfolio would perform during that mean reversion. The resulting understanding has allowed us to alter portfolio exposures to protect against the potential headwind, or to take advantage of a tailwind and generate additional alpha.

We have been actively using this Market Monitor since 2011 to enhance our performance. It now gives us a better chance to outperform under any market condition and add consistency to the portfolio’s return. It was one of the reasons we performed well during the market rally in the second half of 2013 when the Federal Reserve began its tapering operation.

In 2016, we identified a number of higher risk and cyclical stocks that were cheap relative to the market, as well as some defensive stocks that had gotten expensive. Using our model, we adjusted positions in the portfolio to make sure that we were on the right side of that trade. And when risk began to outperform in the second half of 2016, our performance did particularly well relative to our peers, who had positioned more defensively in early 2016.

Q: Do macro factors play a role in your modeling process?

A: Macro factors are not explicitly taken into account in our modeling process. Where they come into play is through our Market Monitor. That’s where we will normally evaluate the impact of macro factors, assess our portfolio exposure, and make appropriate adjustments.

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