KISS Portfolio Construction Process

Since the start of 2018, when the KISS portfolio’s out-of-sample backtest began, the KISS portfolio has generated an average annual return of +20%, which compares very favorably to the average annual return of +10% for the 60/40 portfolio.

Moreover, the KISS portfolio has outperformed while also subjecting investors to lower risk. Specifically, the maximum drawdown of -11% for the KISS portfolio compares very favorably to the maximum drawdown of -22% for the 60/40 portfolio.

Furthermore, the KISS portfolio’s risk-adjusted return, as measured by a Sharpe Ratio of 0.9, outpaces the 0.6 Sharpe Ratio of the 60/40 portfolio. KISS’ Calmar Ratio – the average annual return divided by the maximum drawdown – of 1.9 dramatically outpaces the Calmar Ratio of 0.4 for the 60/40 portfolio. A Calmar Ratio greater than 1 is considered good in institutional finance, thus, KISS’ Calmar Ratio of near 2 is exceptional.

The KISS portfolio was expressly designed for retail investors and RIAs who are fed up with discretionary investment strategies that have caused them to consistently and demonstrably lag broad market returns.

42 Macro Founder and CEO Darius Dale also uses the KISS Portfolio Construction Process to manage his entire liquid net worth.

We developed our Discretionary Risk Management Overlay specifically for long-short investors who have chosen not to implement the KISS portfolio — likely because they are institutional investors or because they believe they can outperform KISS with their own discretionary trading process.

You can find more information about the Discretionary Risk Management Overlay below.

The maximum exposure to each asset class is 60% Stocks, 30% Gold, and 10% Bitcoin.

The actual exposure depends on signals generated by our Global Macro Risk Matrix and Volatility Adjusted Momentum Signals (VAMS).

Specifically, the trend-following strategy employed by the KISS portfolio increases exposure to each asset class when our Global Macro Risk Matrix and VAMS generate incrementally bullish signals in Market Regime terms or for a particular asset class, and decreases exposure when our Global Macro Risk Matrix and VAMS generate incrementally bearish signals in Market Regime terms or for a particular asset class.

Our default Equity exposure is SPY, our default Gold exposure is IAU, our default Bitcoin exposure is FBTC, and our default Cash exposure is USFR.

KISS determines exposure via two independent steps.

First, the Target Allocation is determined by the Top-Down Risk Management Overlay, which is driven by our Global Macro Risk Matrix. If the Market Regime is in a risk-on condition (i.e., GOLDILOCKS or REFLATION), then the Target Allocation for the SPY ETF = 60%. If the Market Regime is in a risk-off condition (i.e., INFLATION or DEFLATION), then the Target Allocation for the SPY ETF gets cut in half to 30%. Gold has historically preformed reasonably well in each Market Regime, so the Target Allocation for the IAU ETF is fixed at 30%. The Bottom-Up Risk Management Overlay will serve as the core risk management system for Gold. If the Market Regime is in a risk-on condition (i.e., GOLDILOCKS or REFLATION), then the Target Allocation for the FBTC ETF = 10%. If the Market Regime is in a risk-off condition (i.e., INFLATION or DEFLATION), then the Target Allocation for the FBTC ETF gets cut in half to 5%.

The Actual Exposure is determined by the Bottom-Up Risk Management Overlay, which is driven by our Volatility-Adjusted Momentum Signal (VAMS). If our VAMS generates a bullish signal for the ETF, the Actual Exposure equals 100% of the Target Allocation. If our VAMS generates a neutral signal for the ETF, the Actual Exposure equals 50% of the Target Allocation. If our VAMS generates a bearish signal for the ETF, the Actual Exposure equals 0% of the Target Allocation – i.e., no position.

Yes. The purpose of KISS is threefold: 1) to help investors block out the noise and remain invested heading into and throughout bull markets; 2) to help investors block out the noise and remain uninvested heading into and throughout bear markets; and 3) to outperform the traditional 60/40 portfolio. KISS can only help investors accomplish these three goals if they dutifully implement each pivot by dollar cost averaging in response to buy signals and selling quickly in response to sell signals.

Over time either the size of the SPY, IAU, or FBTC positions may grow or decline in size relative to the most recent Actual Exposure publication due to market performance. Thus rebalancing is required at regular intervals to minimize tracking error.

There is no right answer for how best to rebalance because each investor has a different tax situation and bandwidth for investing.

The strategy that 42 Macro Founder and CEO Darius Dale employs is to rebalance his portfolio each time KISS signals a change in the Actual Exposure in one (or more) of the ETFs. Per the out-of-sample backtest referenced above, there has been an average of only four trades per month since Jan-18. That equates to four opportunities to rebalance per month, if market performance deems rebalancing is necessary.

Another strategy would be to rebalance on a calendar-based frequency – i.e., at the end of each week, month, or quarter.

Again, there are no right answers for rebalancing. Investors should explore multiple options and settle on what works best for them.

It is always best to dollar cost average (DCA) over time when allocating significant amounts of capital to asset markets. Dollar cost averaging provides investors the best opportunity to take advantage of price dislocations in asset markets to lower the cost basis of positions.

Much like rebalancing, there is no right answer for dollar cost averaging, as much depends on the bandwidth a particular investor might have to execute trades.

The strategy that 42 Macro Founder and CEO Darius Dale employs is to buy a maximum of 1,500 basis points (15% of his portfolio) of a particular position each Friday afternoon until the desired exposure is reached. For example, this strategy would build a 60% position in the SPY ETF from a starting point of 0% over a period of four weeks. If the SPY ETF declined considerably on any weekday prior to Friday, then it is appropriate to pull forward that week’s 1,500bps purchase to that day. No need to wait until Friday in that particular week. He repeats this opportunistic process each week until the position is filled.

Investors may choose different exposures that better align with their strategic investment objectives and risk tolerance. Consult our Discretionary Risk Management Overlay for ideas.

Investors implementing a customized version of the KISS portfolio can execute the Top-Down and Bottom-Up Risk Management Overlays for the ETFs they have selected using the Market Regime observation and VAMS signals published daily in the Discretionary Risk Management Overlay.

The Discretionary Risk Management Overlay does NOT determine the exposures or allocations in the standard KISS portfolio.

The Discretionary Risk Management Overlay should only be used by investors implementing a customized version of the KISS portfolio, or by investors that have elected to not implement KISS.

Investors that choose to implement the standard KISS portfolio need not consult the Discretionary Risk Management Overlay – or any other element of 42 Macro research – for any reason. The Target Allocation and Actual Exposure for the SPY, IAU, FBTC, and USFR ETFs are explicitly communicated in the KISS Portfolio Construction slides.

If you opt to implement a customized version of KISS, the Actual Exposures in your portfolio will differ from the standard KISS portfolio and will depend on the ETFs you have chosen.

Regarding the Top-Down Risk Management Overlay, if the Market Regime is in a risk-on condition (i.e., GOLDILOCKS or REFLATION), then the Target Allocation for your basket of equity ETFs = 60%. You may choose to divide the allocation evenly among ETFs. If the Market Regime is in a risk-off condition (i.e., INFLATION or DEFLATION), then the Target Allocation for your basket of equity ETFs gets cut in half to 30%.

The Target Allocation for Gold remains fixed at 30%. If you elect to diversify out of Gold and into the fixed income asset class, here is how you would do that: If the Market Regime is in a disinflationary condition (i.e., GOLDILOCKS or DEFLATION), then the Target Allocation for your basket of fixed income ETFs = 30%. You may choose to divide the allocation evenly among ETFs. If the Market Regime is in an inflationary condition (i.e., REFLATION or INFLATION), then the Target Allocation for your basket of fixed income ETFs gets cut in half to 15%.

If the Market Regime is in a risk-on condition (i.e., GOLDILOCKS or REFLATION), then the Target Allocation for your basket of alternative ETFs = 10%. You may choose to divide the allocation evenly among ETFs. If the Market Regime is in a risk-off condition (i.e., INFLATION or DEFLATION), then the Target Allocation for your basket of alternative ETFs gets cut in half to 5%.

Regarding the Bottom-Up Risk Management Overlay, if the VAMS for a particular ETF – regardless of asset class – is bullish, the Actual Exposure for that ETF equals 100% of its share of the Target Allocation for the corresponding asset class. If the VAMS for a particular ETF – regardless of asset class – is neutral, the Actual Exposure for that ETF equals 50% of its share of the Target Allocation for the corresponding asset class. If the VAMS for a particular ETF – regardless of asset class – is bearish, the Actual Exposure for that ETF equals 0% of its share of the Target Allocation for the corresponding asset class – i.e., no position.

The KISS Portfolio and the Discretionary Risk Management Overlay are two independent processes that are not intended to be reconciled. The only signals that correspond to KISS are those featured on the KISS Portfolio Construction slides in our research.

The Proper Trade recommendations generated by the Discretionary Risk Management Overlay do not have any impact on the KISS Portfolio Construction Process. Dr. Mo’s signals are only relevant for discretionary investors that have elected to not implement our standard KISS Portfolio Construction Process.

In the event a Market Regime phase transition takes place, it may impact one or more of the Target Allocations for the SPY, IAU, and FBTC positions in KISS per the Top-Down Risk Management Overlay. Any changes will also impact the Actual Exposures for the corresponding positions per the Bottom-Up Risk Management Overlay.

In the event a Volatility-Adjusted Momentum Signal (VAMS) phase transition takes place for the SPY, IAU, or FBTC ETFs, it will impact the Actual Exposure for the corresponding position per the Bottom-Up Risk Management Overlay.

If you are implementing a customized version of KISS, the Top-Down Risk Management Overlay logic still applies to each asset class. You will note any change in the Market Regime at the top of the Discretionary Risk Management Overlay table.

If you are implementing a customized version of KISS, the Bottom-Up Risk Management Overlay logic still applies to each position. You will find any changes in the Volatility-Adjusted Momentum Signal of the ETFs you have diversified into in the VAMS columns of the table.

Please note that the Proper Trade Recommendations in the Discretionary Risk Management Overlay do NOT correspond to KISS. They are only there for investors that have elected to not implement the standard KISS portfolio — i.e., the institutional investors among our client base and the retail and RIA investors that believe they can outperform KISS with their own investment process. We are happy to support them either way.

A general rule of thumb is to be patient when increasing positions and be in a hurry when reducing positions. That is how 42 Macro Founder and CEO responds to KISS Actual Exposure pivots in his portfolio.

When building positions, the strategy that Darius Dale employs is to buy a maximum of 1,500 basis points (15% of his portfolio) of a particular position each Friday afternoon until the desired exposure is reached. For example, this strategy would build a 60% position in the SPY ETF from a starting point of 0% over a period of four weeks. If the SPY ETF declined considerably on any weekday prior to Friday, then it is appropriate to pull forward that week’s 1,500bps purchase to that day. No need to wait until Friday in that particular week. He repeats this opportunistic process each week until the position is filled.

KISS is not designed to trade every wiggle in global financial markets. Rather, KISS is designed to capture the bulk of the medium-to-long-term uptrends in the stock, bond, and crypto markets.

Investors implementing KISS should not attempt to reconcile KISS with any of our other signals. The only signals that clients need to execute KISS are on the KISS “Implement The Pie Chart” slide and in the “Dr. Mo” table if they are implementing a customized version of KISS. Refer to the other entries in our KISS FAQ for insights on how to implement a customized version of KISS. Everything else we publish is essentially irrelevant to you if you are implementing KISS, which we believe provides retail investors the best opportunity to retire on time and comfortably, with relatively minimal effort on the trading front.

All told, if KISS is fully allocated early in a cross-asset correction, please trust that KISS’ Top-Down and Bottom-Up Risk Management Overlays will do their jobs and protect client portfolios from unacceptable losses. Alternatively, if KISS is under allocated early in a cross-asset recovery, please trust that KISS’ Top-Down and Bottom-Up Risk Management Overlays will do their jobs and get client portfolios invested in short order. The quant models that drive KISS’ Top-Down and Bottom-Up Risk Management Overlays were expressly designed to accomplish these critical endeavors.