CPPI – Main Concept

CPPI is essentially a portfolio investment strategy that is designed to dynamically manage the portfolio’s ‘risky assets’ and ‘non-risky assets’, based on pre-defined trading rules. This is a passive investment approach which involves little or no discretion on the part of the Fund Manager.

The main objective of this strategy is to ensure that the portfolio can provide a specified minimum return, either continuously or at a fixed future date, whilst at the same time capturing a proportion of any rise in the underlying market upon which the strategy is run.

In general, as the underlying ‘risky asset’ price rises, then the portfolio’s trading strategy increases its ‘risky’ asset allocation. Conversely, as the ‘risky asset’ price falls, the portfolio’s ‘non-risky’ asset allocation is increased as the ‘risky’ asset allocation is decreased.

The ‘risky asset’ is typically linked to one or more equity market(s). This could be in the form of a managed equity fund and/or equity index futures contracts.

The ‘non-risky’ (or ‘safe’) asset is typically a Cash, Money Market or Fixed-Income fund i.e. instruments that provide the risk-free rate of return. For example, the underlying instruments can include Cash deposits, Zero Coupon Bonds, Swaps and Investment grade bonds.

A common feature of CPPI products is the periodic lock-in of guarantee levels during the term, allowing for example, minimum returns at maturity based on the highest-level reached by the portfolio during the investment period. As CPPI products do not rely on derivate instruments, they also allow for a wider range of asset classes and are less sensitive to option market pricing conditions than option-based products. They are also well suited to continuous offerings.

The main drawback of these products is the possibility of ‘cashing-out’ (see later), as well as the fact that they are ‘path-dependent’, that is the final return is heavily dependant on how the assets perform throughout the return not just where they have ended up at maturity. Another issue is that these products suffer from a reduction in the participation in the equity markets in times of volatile markets.