Constant proportion portfolio insurance, often known simply as CPPI, is a type of insurance coverage that protects an investor in the event of losses that significantly affect the value of his or her investment portfolio. The type of coverage chosen will depend on the nature of the investments that make up the portfolio, with special attention to the degree of risk that is generally associated with those investment types. While the terms of the coverage provided by constant proportion portfolio insurance will vary, the contract usually assigns a floor or minimum value to each asset type, making it possible to maintain coverage even as assets are acquired or sold.
Securing CPPI is often considered a prudent strategy for investors with large portfolios. This type of portfolio insurance makes it possible to develop an asset allocation plan that covers the investor in the event that the value of a given asset slips below the minimum specified amount. As a result, the insurance limits the amount of loss that the investor can experience with any of the covered assets. This is particularly important with investors who make use of strategic asset allocation, a strategy that can sometimes lead to frequent purchases and sales of different assets, based on current market trends.
Typically, constant proportion portfolio insurance makes use of two asset classes. The risky asset class is used for investments where there is a greater degree of volatility present. This would include investments like mutual funds, stocks, or various types of equities. With the riskless asset class, coverage is provided for assets where there is relatively little opportunity for a loss to take place. Assets that would fall into the riskless asset class would include cash assets, government issued bonds, or other investments that are considered safe.
In order to determine the total amount of coverage that is provided by the constant proportion portfolio insurance, the investor will identify a percentage of the portfolio’s value. Often, that percentage is somewhere between eighty and ninety percent. After determining how much coverage is desired, the investor then allocates that amount among all the investments contained in the portfolio. Often, the terms of the insurance would allow the investor to devote more of the coverage to the riskier assets, while allocating a smaller amount to those assets where the degree of risk is extremely low.
Should the value of the portfolio fall below the insured amount stated in the terms of the constant proportion portfolio insurance, a claim for that amount can be filed. Some CPPI contracts will require that the funds from the processed claim be used to purchase cash assets for the portfolio, rather than purchasing riskier assets to bring the total value of the portfolio back up to par. Since there is the possibility for the terms to be slightly different, either due to the nature of the coverage, or governmental regulations that apply to the nation or local area where the investor resides, taking the time to read and understand all the provisions of the contract is extremely important.
