New York (HedgeCo.Net) Pinnacle Capital Management was founded in 2006 and is an investment-management firm catering to individual and institutional investors. Headquartered in Fayetteville, New York, PCM is registered with the US Securities & Exchange Commission. In 2012, PCM launched its first private investment fund, based on the firm’s successful aggressive growth model. Through the use of options and short positions, the fund is able to capture additional investment opportunities. PCM manages the PCM 130 Long 30 Short Equity Strategy on the HedgeCoVest platform and we recently had the chance to speak with Steve Fauer, the firm’s Chief Investment Officer and Portfolio Manager.

HedgeCoVest: Thank you for joining us today Steve.

Steve Fauer: Thanks for profiling our firm.

HCV: On the HedgeCoVest Platform, your model is called the PCM 130 Long 30 Short Equity Strategy. That is a mouthful, but I assume there is significance in the name. Obviously the PCM stands for Pinnacle Capital Management, but what about the rest of the name of the model?

SF: What the name means is that we use an all equity strategy with a target of 130% of net assets invested in the equity market. Now how do you invest 130% of net assets without borrowing? We target 30% of net assets for shorting, so when you short you borrow the shares, sell the stock and take the proceeds and re-invest it in the market. We are not required to be 130% long and 30% short under our guidelines, but those are our targets. Right now we are long 125% of net assets and short approximately 25% of net assets.

HCV: Thank you for that explanation, it makes sense now. Are you more focused on growth or value?

SF: We are value disciplined, but we look for growth as well. We look for growth at a reasonable price. Ultimately we are valuing businesses and the same process that helps us find long opportunities helps us find short opportunities.

HCV: You said that you are currently long 125% of net assets and 25% short net assets. Is that close to the average of the holdings?

SF: I would say that those numbers fall in the normal range. Ideally we have the targets of 130% and 30%, but it depends on where we are in the market cycle. When we are in the early stage of a bullish market cycle, there are an abundance of long opportunities. As the market shifts to the mid-cycle stage we see as many short opportunities as long opportunities. When the market shifts to the late cycle stage, we see more short opportunities and fewer long opportunities. With our investment philosophy and discipline, our approach kind of tells us where we are in the cycle. When we start seeing more shorting opportunities than long opportunities, we know we are entering the late cycle stage.

HCV: The illustration really helps explain your approach. And what you said earlier about the process you go through to find long opportunities also reveals shorting opportunities, that has to play in to this illustration.

SF: Yes it does. When we started Pinnacle Capital Management, we were looking at being a traditional long-only money manager. We never really set out to form a hedge fund, but we couldn’t ignore the results we were seeing from the short opportunities generated from our process. It was after studying the results of the process and how it identified shorting opportunities that we decided to form the hedge fund. The underlying fund that the HedgeCoVest Model is based on was formed in October 2012.

HCV: Beyond the investment process that you go through, how would you describe your investment philosophy?

SF: We have a couple of core values that we adhere to: first, it doesn’t matter whether we are talking about the overall market, individual companies or sectors. Does an investment offer a reasonable return given the risk you are taking on? That is what matters. That being said, we tend to look at the macro picture and we try to look at the economy and the market environment first and then look for companies that can thrive in the current environment. We aren’t necessarily looking at companies that can thrive in this quarter or the next. Rather, we are looking two, three or even four years down the road. When we find such a company we can make a reasonable financial forecast, and we can determine a reasonable valuation for that company. We also try to avoid binary situations.

HCV: What do you mean by a “binary situation”?

SF: A binary situation is one where the investment either works big or it fails. For instance, a biotech firm with one product that is facing FDA approval is a binary situation. It is either approved and the stock takes off or the drug is denied approval from the FDA and the stock is virtually worthless. We also shy away from companies that are involved in major lawsuits.

HCV: That sounds like a Babe Ruth investment strategy, you either hit a home run or you strikeout.
SF: Exactly, and we try to connect with the ball. If we hit a couple of home runs that’s great, but we are more focused on not striking out.

HCV: You mentioned that you are trying to forecast where a stock is going to be two, three or four years down the road. Is that your normal time horizon for your investments?

SF: It is normal, but it isn’t absolute. We want to hold a stock as long as it makes sense. We feel the 2-4 year time frame is kind of the sweet spot of our model. Anything beyond that, the forecasting becomes harder to make because too many things can change—interest rates, economic growth, etc.

HCV: What would you say differentiates your strategy from the rest of the hedge fund world?

SF: Going back to what I said earlier about not setting out to start a hedge fund, I think makes us unique. Most hedge funds don’t start from the perspective of looking for long opportunities and then discovering that the process they use is also useful for finding shorting opportunities. Another thing would be the flexibility of looking at any and all opportunities. Our process isn’t limited to one sector, one country or even one type of economic environment. If an opportunity makes sense from a risk/reward standpoint, we aren’t going to limit ourselves by being narrow in our scope.

HCV: Do you have limitations on what percentage you are willing to be long versus the percentage short?

SF: Philosophically, I have no problem being 100% short if that is what the research and the process tells me is how it should be. Our target is 30% short, and we can be there with absolutely no long positions. Will we ever reach that point? I doubt it, but as I said, our flexibility is an advantage in my opinion. If we were a long-only manager and were in the late cycle of a bull market, I may only see one out of 10 stocks that meet our criteria to go long and six or seven out of 10 meet our criteria for shorting. You have to have flexibility. Being able to look wherever the opportunities lie is important.

HCV: Shifting gears a little, what do you think is the biggest issue facing the hedge fund industry at this time?

SF: I think it’s really perception. Due to a lack of knowledge, it is a perception that all funds use excessive amounts of leverage. It is a perception that hedge funds are only for the wealthy. There is a perception that most hedge funds are high frequency trading strategies.

HCV: Thank you so much for taking the time to speak with us today Steve, it has been an interesting conversation.