The JLFMI Risk Model - When to be invested?
Central in our investment strategy is the proprietary J. Lyons Fund Management, Inc. Risk Model, which aids us in being on the right side of significant stock market moves. It was developed in the mid-1970's by JLFMI founder and president, John S. Lyons, and has been in use now, with only minor modifications, since 1978.
How does the
Risk Model work?
The Model consists of several quantitative measures of data sets
derived
directly from the
stock market which represent various measures
of risk and momentum in the market. Collectively, they provide us with
a reading on the overall level of risk present in the market and
dictate our investment posture. When the Model is in a "Buy" mode, it
is indicating that the market risk is low enough that
significant investment exposure is warranted. Conversely, when the
Model is in a "Sell" mode, it is a warning that the risk
present in the market is high enough that our focus should be on
protecting our capital, meaning little or no investment exposure.
How does the
Risk Model behave?
The goal of the Model is not
to target every little gyration in the market -- that would be too
costly, not to mention, unrealistic. The goal is to identify just those
significant, tradable moves in the market and, hence, we are not
constantly moving in and out of the market. Historically, the Risk
Model has generated an average of 3-4
signals a year.
How effective
has the Risk Model
been?
» Since its inception
in 1978, when the Risk Model has been in a "Buy", the stock
market (as measured by the Value Line Composite) has risen at an
annualized rate of +18.2%.
» Since 1978, when the Model's been in a "Sell", the market has declined at an annualized rate of -10.2%.
One of the salient features of the Risk Model is the objectivity that it lends to our decision-making. Since the Model's components come directly from market itself, it gives us an accurate read on what the market is actually doing rather than having to rely on external data (fundamental, economic, etc.) to subjectively try to forecast what the market will do.
Is the Model pinpoint accurate? Certainly not -- no system is. For example, most approaches, including buying-and-holding have serious and obvious deficiencies in declining markets which virtually guarantee the occurrence of damaging losses on a regular basis. However, since the components of the Risk Model, again, are direct measures of the market, by definition it cannot be wrong for very long.
Furthermore, pinpoint accuracy is not required to produce exceptional rates of return. The ability to be correctly positioned for most of the significant trends in the stock market is what is necessary. The Risk Model has enabled us to do just that and we are confident that it will be just as effective in the future as it has been in the past. Most importantly, in the difficult investing environment that has existed since 2000, and that is likely to persist for several years to come, we believe that utilizing this type of approach is the only way that investors will even have a chance at investment success.
