CPPI’s are capital protected products that shift actively between two asset classes, one being a capital protected asset and the second, a risky asset (e.g. funds, indices, hedge funds etc.) When markets are falling, majority is invested in the capital protected component, and when markets are rising majority is invested in the risk assets. Ideally these products have more assets invested in the risky asset when it increases in value, and less when it decreases.
There is a possibility of the risky asset losing a substantial amount which might trigger a cash-out event which means that all the funds will be kept in the capital protection component and there will be no amount invested in the risky asset.
Advantages
- Dynamic hedging allows funds to be re-allocated between the capital guaranteed component and risky assets
- No fixed participation
- Leverage can enable participation to increase above 100% for certain structures. The issuer bear the leverage risk (not investors)
- 100% of nominal amount is protected, even for the leveraged part of the product
- Multiplier corresponds to liquidity and volatility, so structure is flexible
- Many underlyings which cannot be used for option-linked structures may still be suitable for CPPIs
- Many variations possible
- The multiplier can make the structure attractive in a low-interest rate environment