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. Asset Allocation

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

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

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

    The technique of buying a fixed dollar amount of a particular ...
  6. Value Averaging

    An investing strategy that works like dollar cost averaging (DCA) ...
Related Articles
  1. 5 Tips For Diversifying Your Portfolio
    Investing Basics

    5 Tips For Diversifying Your Portfolio

  2. Modern Portfolio Theory: Why It's Still ...
    Active Trading

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

  3. Dollar-Cost Averaging Pays
    Retirement

    Dollar-Cost Averaging Pays

  4. How the Affordable Care Act Changed ...
    Insurance

    How the Affordable Care Act Changed ...

comments powered by Disqus
Hot Definitions
  1. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  2. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  3. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  4. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  5. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
  6. Limit-On-Open Order - LOO

    A type of limit order to buy or sell shares at the market open if the market price meets the limit condition. This type of ...
Trading Center