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   Interview

    Guest Interview:

   Pacific View Asset Management, LLC

    600 Montgomery Street, 6th Floor
    San Francisco,CA 94111

    Telephone: 212-277-1062
    Fax: 415-318-5801
    E-mail: BContant@pacviewam.com

 

    Interview Quarter: 4Q2016

 Mike Ashton, CFA

 Portfolio Manager

  Mike, please tell us what differentiates Pacific View Asset Management from other investment management firms?  
  Pacific View Asset Management, LLC (“Pacific View” or “PVAM”) is an entrepreneurial, multi-discipline asset management firm. Our organization was founded with a mission of offering private investors and institutional allocators high value added investment services. We have terrific resources for a firm of our size, which allow us to provide our clients with an exceptional level of service and at reasonable fee levels.  
  Who are the founders of PVAM and what were the motivations in starting the company?  
  Pacific View was founded by Condor Trading, LP (“Condor”), a privately held partnership that owns and controls several financial services organizations, including BTIG, LLC, and an institutional broker-dealer specializing in institutional trading, investment banking, research and related brokerage services. The partners of Condor believed there was demand for unique, actively managed investment strategies, but recognized a dearth of smaller firms being formed to offer these investment solutions, due to the costs associated with launching an investment advisory firm particularly in the current regulatory environment.  
  Please list the investment strategies you offer.  
  We currently have two portfolio management teams focused on traditional long-only public equity investments and one team focused on late-stage venture capital opportunities.

I manage our U.S. Growth Equities strategies, which consist of two composites, Small Cap Growth and Large Cap Growth.

Jim Boucherat and David LaSalle co-manage the PVAM Perlus Microcap strategy which is focused on investing in the shares of companies with market capitalizations of $250 million or less that trade in the U.S. and Canada.

Joan Schriger and Brian O’Keefe co-manage PVAM Select Venture Growth strategy, a venture capital initiative committed to late-stage (post-product/post-revenue) investment opportunities in the technology sector.
 
  Mike, is there an overriding investment philosophy that you follow?  
  We believe the momentum factor, when accessed at reasonable prices, is the best method for generating consistent, risk-adjusted, excess returns. We refer to the investment strategy based upon this philosophy as “Momentum at a Reasonable Price.” This approach was developed over the course of several years working with the momentum factor and observing its advantages and disadvantages. The discipline that our "reasonable price" requirement brings to the investment process has proved to be a significant benefit in addressing one of the greatest challenges of utilizing momentum – the tendency for high growth expectations to temporarily inflate valuations, frequently resulting in boom-and-bust return cycles for growth stocks.

Our affinity for the momentum factor as a source of excess return is derived from research conducted by the academic and investment communities over the past twenty-five years. These studies show that outperforming stocks tend to exhibit persistence in their outperformance. This is what we mean by the term "momentum," and in simple terms, it refers to the tendency of stocks that have outperformed their peers in the past to continue their outperformance into the future. In our opinion, the most effective way to generate consistent, risk-adjusted excess returns is to take overweight exposure to the momentum factor, but only to the extent that the valuations of stocks exhibiting momentum are reasonable. Our focus on valuation is predicated on our belief that mitigating the downside risk from excessive valuation is an essential element of portfolio risk management.

Looking forward, and based on our experience utilizing momentum, it should continue to be a sustainable and exploitable inefficiency due to the existence of behavioral biases exhibited by investors. The most significant bias, which explains the ongoing existence of momentum in equity markets, is probably the anchoring of new forecasts to old assumptions. Most often we see this occur when new information about the future path of earnings is not immediately, correctly, and fully integrated into market prices by all investors. Our investment process seeks to identify and exploit this incomplete integration of new information.

The investment process itself is a bottom-up endeavor, as we seek to identify stocks with positive exposure to the momentum factor that also have a recent history of upward earnings revisions and that we believe have a high probability of future upward earnings revisions. As part of this process, we eliminate from consideration stocks that trade at high valuations relative to their historical range, as we feel that investment success depends, in no small part, upon entering investments at sensible prices.
 
  You describe your philosophy as momentum at a reasonable price – is it possible to find reasonably priced momentum stocks?  
  There is widespread belief that momentum implies runaway stock prices and nosebleed valuations. The reality is more nuanced. While frequently there exists a subset of stocks that displays both positive price momentum and trade at an extremely high valuation, this group of stocks represents only one point on the continuum of momentum and valuation. One of the key aspects of our investment process is that the higher valuations become within the momentum subset of stocks, the less momentum exposure we tend to have.

When we update and review our momentum screen each week, we focus specifically on stocks in the top quartile of the screen. We then eliminate those trading notably above their 3-year and 5-year historical valuation multiples (e.g., P/E, EV/EBITDA, EV/Revenue). What we are left with are those stocks which we believe are reasonably priced. Occasionally we have many candidates that warrant further investigation after these initial steps, but at other times we have very few. During those periods when the momentum screen is not generating attractive risk/reward opportunities, one of the most unique elements of our investment process is we comb through our benchmark and pull from it companies that are attractively priced or provide exposure to factors that we are most desirable for the given market backdrop.

As a result, we are likely to be overweight the momentum factor when reasonable valuations exist, and we are likely to have less momentum exposure when our available opportunities are expensive. By using the benchmark as a safe harbor during expensive periods for the momentum factor, we can calibrate our risk factor exposures to become more aggressive during high opportunity environments and to become more conservative during low opportunity environments.
 
  What makes your investment process unique?  
  First, we focus on the momentum factor to generate upside relative to the market; we feel it is an underutilized source of returns for investors. We believe, however, it can be difficult to generate consistent returns using this factor exclusively, as it is subject to periodic reversals and significant underperformance when implemented as a simplistic rule of always being heavily overweight the momentum factor regardless of valuation. Our goal, on the other hand, is to access momentum only when valuations are reasonable and fundamentals are sound, and then to exit momentum positions as risks mount. This creates a constant refresh in the portfolio, which leads to proactive selling and allows our momentum exposure to adjust as market conditions evolve.

Second, we utilize our momentum screen, not only as a source of ideas on the upside, but also as a critical element in our risk management process. When we find that the momentum factor has become expensive, overcrowded, and has outperformed for longer than average, we use these signals to reduce our momentum factor exposure. In most cases, we reallocate capital within the portfolio to increase diversification. In some cases, where momentum has become unusually expensive, we will underweight the factor in order to take advantage of the reversion in valuations to more normal ranges.

Third, we use our factor model in all market environments to analyze and understand the sources of portfolio risk and to see which factors may be advantageous for managing risk. Thus, factors are an important aspect of our investment process, whether we are leveraging to momentum factor to generate alpha, or we are diversifying across non-momentum factors to control risk. To this end, our factor work is an essential complement to our bottom-up work.

Since we launched these strategies, these elements have come together in a risk/return profile that compares very favorably to the Russell 2000 Growth Index and Russell 1000 Growth Index. With Small Cap in particular, we have outperformed the index in up markets and significantly outperformed the index in down markets.
 
  What exactly is “alpha” and why is the concept important to investing?  
  Alpha is the risk-adjusted excess return of a portfolio compared to a benchmark index. We tend to maintain our beta, or benchmark-relative volatility, at or somewhat below 1.0. Our goal in this approach is to take risk that is similar to or below that of the market while producing similar or higher returns than the market. This reflects our dual focus on valuation and earnings potential. Since extremely high growth expectations are generally reflected in higher valuations, we seek to find a more balanced risk/return profile where fundamentals are very strong but valuations are reasonable. Ideally this approach leads us to investments where there are two ways to win: upward earnings revisions and valuation multiple expansion.  
  Could you describe your research process and how you profit from behavioral biases?  
  Once the team identifies a potentially promising investment, we develop a forecast of future earnings potential. This forecast integrates research on historical earnings drivers, recently released earnings information, and any forward-looking statements – such as earnings guidance – provided by company management. Analysis of a company’s financial filings, review of sell-side research, construction of earnings models, and participation in quarterly earnings conference calls are essential elements of this process.

The team will then attempt to identify behavioral biases that frequently occur during the integration of new information into stock prices. The primary biases the team looks for are: (1) anchoring of future earnings expectations to prior earnings expectations, and (2) conservatism in estimating large changes to a company's earnings growth potential. Expression of these biases can be found in both the sell-side analyst community and company management teams. The combined impact of these biases can create significant pricing inefficiencies that are reflected in consensus earnings expectations that significantly underestimate near-term earnings potential. When examining the assumptions of the sell-side analyst community, the team looks for instances where sell-side earnings expectations for a given company may be too low due to excessive reliance on prior earnings models, or reluctance to abruptly make significant and unexpected changes to earnings assumptions. The tendency of sell-side analysts to rely on management's forward earnings guidance can compound these effects. Consideration of sell-side analysts' valuation methodologies are also conducted to determine if valuation multiples are likely to increase beyond levels implied by consensus expectations due to underappreciated positive earnings momentum.
 
  What are market inflection points and how do you deal with the elevated risk of performance volatility during these periods?  
  Inflection points are periods when market leadership changes abruptly, often accompanied by a significant increase in volatility. If you look at a chart of the broad market, these periods are most often associated with V-shaped tops and bottoms, frequently followed by a phase of volatility, before new leadership emerges. Conventional momentum strategies tend to increase their exposure to the prevailing market trend as the trend matures and approaches its end. These trends tend to go out with a bang rather than a whimper, which makes end-stage momentum extremely risky.

Our approach to managing the risks inherent in inflection points is to be very proactive in our sell process. This means that as prices appreciate and valuations expand, we are constantly looking for the right opportunity to exit. This approach is in contrast to many investment strategies that sell after it is apparent that fundamentals have changed. While we sometimes sacrifice some upside with our approach, the regret of missing the last, riskiest phase of the trade is far preferable than the regret that accompanies staying around too long and potentially round-tripping a trade – or worse, turning an unrealized gain into a realized loss.
 
   
  Outside of inflection points, how do you manage downside risk?  
  We are preoccupied with managing downside risk in all market environments and spend at least fifty percent of our time on this aspect of portfolio management. This preoccupation stems from our experience with small cap stocks and the momentum factor, where a single piece of bad news or a poor earnings report can lead to single-day losses in excess of twenty percent. We have found that constantly thinking about what could go wrong provides the best lens for evaluating downside risk on a daily basis. To stay focused on this task, we have incorporated three essential steps into our investment process: (1) only initiate positions where valuation is reasonable and, thus, more likely to work in our favor than against us; (2) be very proactive in reducing position sizes as price appreciation occurs; and (3) use the benchmark as a safe harbor to diversify when conditions warrant.

Initiating positions at valuations at or below historical averages not only mitigates the risk that a richly valued stock returns to more normal valuations based on a change in sentiment or unmet fundamental expectations, but it also provides a very good directional setup to profit from multiple expansion in the case of a stock where expectations start low and then build as more investors begin to appreciate the improving fundamentals.

Taking a very proactive approach to trimming positions that are working for us is another important way that we manage risk. In fact, the primary driver of a decision to trim or sell a position is an unfavorable change in risk/reward profile driven by price appreciation (i.e., all else equal, a higher price creates more downside risk and less upside reward). We are very proactive in realizing gains while a stock is in favor, liquidity is deep on the bid side of the trade, and before there is a negative change to fundamentals. This is a differentiated approach as we have found that many peers hold their positions until there is a change in fundamentals, thereby experiencing extremely severe downward price reactions to negative news as everyone attempts to exit the trade simultaneously.

Finally, we make use of our benchmark index to help us manage downside risk. We use a factor model to understand the portfolio's sources of risk across industries and style factors (e.g., growth, momentum, value) in relation to our benchmark index. When we are finding a number of reasonably valued momentum stocks, our need for diversification tends to be lower as we seek to take advantage of these opportunities. However, when momentum displays increasing warning signs, we generally diversify across industries as well as style factors. This results in lower overall risk as we take exposure to more industries but often in more modest proportions, and as we lower our momentum exposure and spread it out to other style such as growth or dividend yield.
 
  What is your process for deciding when to trim or sell a position?  
  As discussed in the previous question, the primary driver of a decision to trim or sell a position is an unfavorable change in risk/reward profile driven by price appreciation.

The secondary driver of a trim or sale of a position is a build-up of informational risk. Since much of the portfolio's stock-specific risk is derived from earnings reports, we are careful to mitigate our exposure to such events when practicable. As a general rule, we strongly prefer to hold our largest position sizes immediately after new information – such as quarterly earnings results – have been disseminated to the market, and to hold our smallest position sizes immediately before new information is disseminated to the market.

The tertiary driver of a trim or sale of a position is a change in fundamentals. This is our least preferred reason for selling a position, as outcomes tend to be better when we sell due to price appreciation or to mitigate information risk. However, because it is not possible to entirely eliminate exposure to the risk of a change in fundamentals, there are instances when such a change is the reason for the sale of a position.

For those stocks held for the purpose of managing or diversifying risk, the primary factor driving a sell decision is an increase in the prevalence of attractively priced stocks within the momentum factor. A risk management position also may be sold if its fundamental characteristics change, such that it no longer fulfills its intended risk mitigation role, or if portfolio risk requirements change.
 
  Are there market environments when you are more likely to outperform? And what types of market environments are most challenging for your investment process?  
  The U.S. Growth Equity strategies are likely to outperform when the price performance of individual stocks has a strong correlation with underlying fundamentals, as reflected in stock prices that are well anchored to historical valuation multiples. These conditions may prevail in both upward and downward trending markets; market direction itself is not a determinant of relative performance.

In an environment where fundamentals are well anchored to valuations, our investment process has a track record of identifying outperforming stocks that have a high probability of continuing their outperformance. This outperformance is rooted primarily in the team’s ability to consistently identify stocks that are likely to exceed consensus earnings expectations, which frequently leads to stock price outperformance. It is also related to the ability to identify stocks where valuations are reasonable such that risk/reward potential is at worst evenly balanced between upside and downside outcomes due to changes in valuation multiples.

The strategies are likely to underperform when dislocations between fundamentals and valuation occur. This effect can impact relative performance in both upward and downward trending market environments. Because we believe that valuation is an essential component of a stock's risk/reward profile, we always consider valuation when evaluating an investment candidate. To the extent that historical valuation multiples are poorly correlated with prevailing price performance in a given market environment, our strategies are more likely to underperform their benchmark indexes.
 
  Who are your analysts, what are their backgrounds, and how do you work together?  
  Leanne Karns and Thomas Tatum work with me on the investment team. They are focused on the fundamental analysis of companies that we identify through our momentum screen as well as the companies that we use from the benchmark to manage risk. In all cases, we are reading regulatory filings, building financial models, and developing price targets for upside and downside scenarios.

Leanne Karns is our Senior Equity Analyst. Before joining Pacific View, Leanne was an analyst at Cannell Capital for a long/short small cap equity strategy. She has also worked at Polestar Capital and Marsh & McLennan. Leanne earned her BS in Mathematics and Economics from the University of Illinois and her MBA from the University of California, Los Angeles.

Thomas Tatum is our Equity Analyst. Before joining Pacific View, Thomas gained experience at White Oak Global Advisors, Medley Management, and Balyasny Asset Management. Thomas completed his BS in Political Science at Santa Clara University.

As a team, we work together very closely beginning with our daily morning meetings. We then discuss the portfolio, new investment candidates, and current events relevant to our investment strategy throughout the day. Earnings season is the busiest time for us, as we strive each day to identify new investment ideas as soon as earnings reports are announced. We look at all relevant earnings announcements, listen to earnings conference calls, and work diligently to process the news and synthesize an investment thesis before the new information is fully priced into the respective stocks.

My role is to implement the strategy at the portfolio level by sizing positions appropriately, understanding how the stocks in the portfolio work together, and constantly managing our risk exposures. Leanne and Thomas are focused on analyzing company-specific catalysts and risks that are essential to evaluating our investment thesis. Operating in this fashion allows us to respond quickly to new information, which we see as imperative for operating an investment strategy such as ours.
 
  How much capacity do you have in each strategy?  
  Our Small Cap Growth strategy has capacity of $1 billion and our Large Cap Growth strategy has capacity of $3 billion. We believe that constraining capacity, especially in the small cap segment of the market, is essential to being able to access the best opportunities without being frozen out by liquidity issues. Likewise, it is critical for us to be able to find sufficient liquidity when exiting trades. By maintaining adequate liquidity at both trade entry and exit, our performance – and our outcomes for clients – is likely to be better than if we simply aimed to grow our assets under management as much as possible.  
  How can investors find out more about PVAM?  
  We welcome any inquires on our firm, investment process or other services offered by Pacific View. Feel free to call or email Brendan Contant, President, Pacific View Asset Management, who can be reached at (212) 277-1062 or bcontant@pacviewam.com.  
  Disclaimers  
  Past performance is not indicative of future results. Investment returns include both realized and unrealized gains and losses, reinvestment of income and dividends. Gross performance is presented net of transaction costs, interest income and capital gains, but does not include the deduction of investment advisory fees or custodial fees. Net performance is calculated by reducing the gross results by an annual investment advisory fee of 1.00%, applied on a monthly basis.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 Index companies with higher price-to-value ratios and higher forecasted growth values. The Russell 2000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the small-cap growth segment. The index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set and that the represented companies continue to reflect growth characteristics.

The Russell 2000 Growth Index performance presented is not directly comparable to the performance of the U.S. Small Cap Growth Strategy because this index is not actively managed, represents a more broadly diversified mix of equity securities and does not reflect the deduction of any transaction or management fees or costs. Performance data of the index was obtained from publicly available sources. The presentation of index data does not reflect a belief by Pacific View that the index is an investment alternative to its strategies. The index may be useful in measuring performance and is included to provide some indication of the performance of the U.S. small-cap markets generally, but Pacific View cautions clients that comparison with any market index may be inappropriate because Pacific View's portfolios may not be as diversified as the index shown.

This document has been prepared solely for informational purposes. Pacific View is an institutional asset management firm and is currently registered with the State of California as an investment adviser. Additional information regarding Pacific View may be found at: http://www.adviserinfo.sec.gov. Past performance is not indicative of future results. Pacific View has no obligation to update, supplement, or correct any information contained herein.
 
 
 
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