8Ralph Vince and Richard Wilkie are a team. That is abundantly clear to anyone who listens to them speak or make a presentation. They defer to each other and finish one another's sentences. And they both feel that they have developed an investment philosophy that could change the way people look at asset management.Ralph is president and Richard is secretary and treasurer of LSP Partners LLC. Their innovative leveraged space portfolio (LSP) is a unique strategy designed to maximize the probability of equity portfolio profitability by using a risk-control-based design. Though they view it as a "conservative" method, it differs from a traditional buy-and-hold approach in that it seeks to earn more consistent returns with a corresponding lower risk. It uses cash to support the strategy when the stock market is going up, and to hedge when the market is going down.The author of five books with titles that include The Mathematics of Money Management and Portfolio Management Formulas, Ralph has spent his life trying to figure out ways to enhance investment returns using math. Richard sought him out after using Ralph's model to great success in his own portfolio.LSP Partners recently teamed up with Dow Jones Indexes to develop the Dow Jones LSP Position Sizing Indexes, which are designed to be a rules-based application of their LSP strategy. The first index in the series launched in January. Ralph and Richard have been traveling the country ever since, meeting with portfolio managers and exchange traded fund (ETF) providers, explaining the benefits of a rules-based approach to investing. They recently came to visit Dow Jones Indexes in Princeton, N.J., to give a presentation to its employees. In between meetings, they sat down to discuss the strategy behind the indexes.Ralph: I'm a math guy at heart. I've worked with many, many types of people who are interested in risk, from Wall Street traders to professional gamblers. The one thing that I tell everyone is: The only factor you can control in a situation like the stock market is quantity; in other words, the amount that you're willing to put in. Each investor controls how much of his money is being invested and how much isn't. That's what lies at the heart of LSP and is the model that forms the basis of the new Dow Jones LSP Position Sizing Indexes.Richard: We always have to explain to people that we're not traders. LSP is a rules-based sizing overlay. There's no prediction involved, and we don't do timing. It's probability theory. It's an attempt to improve the probability that we'll get a better return than by stock picking or random sampling. Ralph: What makes our LSP strategy different is how funds are moved from cash to equities. We initially use less than 50% of cash in stock positions. The rest is in cash. This way, we have additional cash available should equities become more attractive.Partner ProfileLSP Partners LLCRalph VincePresident, LSP Partners LLCRichard WilkieSecretary and Treasurer, LSP Partners LLC
9Richard: This allows LSP to put the focus on capital preservation and drawdown management. Ralph: Right, the strategy is designed to make "dynamic quantity allocations" in regards to the dollars being invested. An investor can't control the marketplace and can't outguess it, either. What can be controlled is how much money is put to risk.Richard: Picture it as whether you're going to buy five shares of a stock or 5,000 shares. It's your decision. You want to buy in, but for some people, "buying in" has a different meaning altogether. Or to use a more colloquial example, are you going to put $5 at the roulette table or $5,000. That's what you control, not whether the ball will land on black or red.Ralph: As Richard says, the indexes aren't fully invested to begin with. That's not very common in investing. By holding onto money, right off the bat we're breaking with investment orthodoxy. Richard: That's absolutely correct. You expect that if a fund manager has $1 million, he or she will buy $1 million worth of stock. LSP mandates that you initially use less than $500,000. The rest is for later use. It's extremely counterintuitive. It goes against a lot of people's thinking. Ralph: The LSP formula, which underlies the model behind the Dow Jones LSP Indexes, is unchangeable. It mandates that there be unused cash. That actually gives us a lot of freedom to act when necessary. For instance, if the market becomes more attractive, then the cash reserves come into play in a predetermined progression. Conversely, if the market goes up, the rules dictate that cash positions are increased.Richard: We always say that the beauty of our LSP strategy is that it's rules-based. Ralph: Yeah, I think we already said that. (laughs)Richard: (laughs) I wouldn't doubt it. It's the heart of the overlay strategy. It eliminates the human factor and all its biases and pre-conceived notions. It's simply an algorithm to determine quantity through time. LSP is very dynamic. It allows for positions to be adjusted, or trades to be made, in every possible scenario, whether the market's going up or down. It's not a trading system.Ralph: The fact is that LSP adapts really well to market conditions. The reason that people are drawn to these indexes is that they have risk control built in. After so much carnage in 2008 and 2009, people want to know that we have volatility in mind.Richard: Actually, the strategy works well with volatility. You see, our model reacts to upward or downward movement by adjusting the size of the cash position. Since we can't predict volatility, we made sure that LSP would be able to take advantage of it in both bull and bear markets. It's meant to be so dynamic that it'll work in any market situation.Ralph: It's like building a ship: You need it to be the strongest possible model so that it can weather any storm. You can't know if there's going to be bad weather or blazing heat, but you can be primed for both. LSP prepares you for any development. You're never wishing, "If only I had more capital, I'd be able to go long or short on a position." LSP gives you that ability.Richard: If you were 100% invested, there'd be no room to maneuver. In fact, when we meet with people all over the country, such as ETF providers, we tell them that they're probably over-invested. "The fact is that LSP adapts really well to market conditions. The reason that people are drawn to these indexes is that they have risk control built in. After so much carnage in 2008 and 2009, people want to know that we have volatility in mind."