CPPI or Constant Proportion Portfolio Insurance is a strategy in which the investor sets a floor on the value of his portfolio. Next, two asset classes – a risky asset and a safe (conservative) asset – are used to minimize the risk the portfolio value breaks the floor.

The difference between the start value or the peak of the portfolio and the floor value, is called the cushion. The percentage of the portfolio allocated to the risky asset, is determined by the cushion and a multiplicator (which we will call ‘m’). For example, if the start value is 100, and the floor is set to 80, the multiplicator to 3, 60%(20*3) of the portfolio value is allocated to the risky asset. Rebalancing can be done on a regular basis: daily, weekly, monthly, quarterly or even yearly.

In the next chapters we’ll perform backtesting in order to determine whether in the past, this strategy was able to limit the downside risk of investing. And we’ll see what kind of returns we could have expected using this strategy. We will use historic prices of an ETF of a major stock index as risky asset. We assume a fixed yearly return for the safe asset, conservatively set at 0.5%.

CPPI first analysis