Last Updated on 10, June 2014
For those who prefer to read, the following is a transcript of the video:
The constant proportion portfolio insurance or CPPI strategy is one of the strategies often used by fund managers in funds which offer some kind of capital protection. To me, it is not a good strategy because it often yields unsatisfactory results. This is how it works: in a CPPI strategy, the portfolio is invested in safe and risky assets. When the market is moving in an uptrend, more money is channeled to the risky assets. That is to say that the percentage in risky assets increases during the bull market. When the market is in a downtrend, risky assets will be sold so as to reduce the percentage invested in the risky asset. If the market continues to be in a downtrend, the percentage invested in the risky asset approaches zero. That is to say that the entire portfolio will no longer be invested in risky assets. Here are three reasons why I feel the CPPI method is not a good way for capital protection:
First, buying more risky assets in an uptrend market is effectively buying high. Selling risky assets when market comes down is equivalent of selling low. Buying high and selling low does not sounds very appealing to me! In an oscillating market in which the average return of the market is zero, the CPPI is losing money.
Second, if market crashes, the entire portfolio will be “lock-up” in safe assets resulting it to be permanently out of the market. This means, there will no longer be any potential upside. I have seen this happening during the financial crisis in which a CPPI portfolio ceased to have any volatility. As I suspected, its entire portfolio was invested in safe assets and no longer able to participate in the uptrend.
Third, when the entire portfolio is “lock-up” in safe assets, the investor still has to wait for the fund to ‘mature’ because it takes time for the safe assets to appreciate to the original principal investment amount. In the meantime, there is lost in opportunity to invest in better performing investments.
Therefore, the next time someone asks you to invest in a capital protection fund, ask them what strategy they use. There are other better strategies. If in doubt, always consult a professional investment adviser.
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