Constant Proportion Portfolio Insurance - CPPI

AAA

DEFINITION of 'Constant Proportion Portfolio Insurance - CPPI'

A method of portfolio insurance in which the investor sets a floor on the dollar value of his or her portfolio, then structures asset allocation around that decision. The two asset classes used in CPPI are a risky asset (usually equities or mutual funds), and a riskless asset of either cash, equivalents or Treasury bonds. The percentage allocated to each depends on the "cushion" value, defined as (current portfolio value – floor value), and a multiplier coefficient, where a higher number denotes a more aggressive strategy.

INVESTOPEDIA EXPLAINS 'Constant Proportion Portfolio Insurance - CPPI'

The investor will make a beginning investment in the risky asset equal to the value of:

(Multiplier) x (cushion value in dollars)

and will invest the remainder in the riskless asset. As the portfolio value changes over time, the investor will rebalance according to the same strategy.

Consider a hypothetical portfolio of $100,000, of which the investor decides $90,000 is the absolute floor. If the portfolio falls to $90,000 in value, the investor would move all assets to cash to preserve capital.

The value of the multiplier is based on the investor's risk profile, and is typically derived by first asking what the maximum one-day loss could be on the risky investment. The multiplier will be the inverse of that percentage. So, if one decides that 20% is the maximum "crash" possibility, the multiplier value will be (1/.20), or 5. Multiplier values between 3 and 6 are very common.

Based on the information provided, the investor would allocate 5 x ($100,000 - $90,000) or $50,000 to the risky asset, with the remainder going into cash or a riskless asset.

The timetable for rebalancing is up to the investor, with monthly or quarterly being oft-cited examples. Ideally, the cushion value will grow over time, allowing for more money to flow into the risky asset. If, however, the cushion drops, the investor may need to sell a portion of the risky asset in order to keep the asset allocation targets intact.

RELATED TERMS
  1. Strategic Asset Allocation

    A portfolio strategy that involves setting target allocations ...
  2. Dual Rate Income Tax

    An income tax rate structure in which two different tax rates ...
  3. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  4. Asset Management

    1. The management of a client's investments by a financial services ...
  5. Portfolio Insurance

    1. A method of hedging a portfolio of stocks against the market ...
  6. Dollar-Cost Averaging - DCA

    The technique of buying a fixed dollar amount of a particular ...
Related Articles
  1. Investing Basics

    5 Tips For Diversifying Your Portfolio

  2. Active Trading

    Modern Portfolio Theory: Why It's Still ...

  3. Retirement

    Dollar-Cost Averaging Pays

  4. Insurance

    What are the tax implications of a life ...

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Conduit Issuer

    An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects ...
  3. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  4. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  5. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  6. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
Trading Center