Open-ended constant proportion portfolio insurance (CPPI) is being considered as the next alternativ...
Open-ended constant proportion portfolio insurance (CPPI) is being considered as the next alternative to with-profits and can offer greater upside potential than its traditional counterparts, according to David Macdonald, head of domestic and offshore insurance retail solutions at Barclays Capital.
Macdonald said: "An open-ended CPPI is an ideal investment for unit-linked annuities and can be used to replace the with-profit product as the staple investment choice. It presents opportunities for managing clients who fall into the cautious managed space or clients who wish to save for a future event such as university funding. It also provides an investor with protected exposure across a range of asset classes.
"An open-ended CPPI has been designed so the product never falls below a fixed percentage of the highest ever net asset value (Nav). The structure has the ability to recover in the event of cash-locking unlike a traditional CPPI and is not exposed to changes in interest rates."
For example, if the protected Nav was 80% of the highest ever value of the fund and the product performance increased in return, the protected value would also increase, meaning if the equity market was to rise by 5% then the amount protected would also rise by the same amount. This would remain locked in for investors, explained Macdonald, and would not fall even if the market did.
This model compares to a traditional CPPI, which does not offer this type of participation in the market. Macdonald stressed that while the investor did get to participate in the growth of the equity market by using a traditional CPPI product, if the market was to fall the investor would only get back the initial investment.
In a traditional CPPI, the product also has a floor, which is the lowest acceptable value that the Nav can fall to at maturity. For example, if the present value was £100 in five years time, £80 might be the acceptable level that can be returned over this period. The floor invests in a zero coupon bond, which moves up and down with interest rate changes.
To give investors exposure to the equity markets and achieve greater returns, the difference between the floor and Nav is invested, said Macdonald. This has been called the cushion that has been predetermined by a multiplier, which depends on the volatility of the riskier assets and the asset allocation needed to give the investors a return over the present value. However, if the risky assets were to fall in value, the investor would only get back the present value.
He added: "The higher the multiplier, the greater the participation in a rising market. However, the higher the multiplier, the quicker the cushion will be eroded. Once the cushion has been eroded, the structure is 100% invested in the zero coupon bond with no chance of recovery. If cash-locking occurs in the early years of a structure, there is no means of participating in a subsequent market recovery."
There has been a growing number of open-ended CPPIs launched in recent years, according to Macdonald, which have invested in different types of asset classes such as indices and funds, with the majority offering protected levels of 80%.
These include the Threadneedle Protected Profits and the Zurich Assurance Sterling Protected Profits, which gives investors exposure to three internal Threadneedle funds, while the Axa Active Protector fund also provides exposure to the FTSE 100 and the Friends Provident Life & Pensions Stewardship UK Safeguard Optimiser fund provides exposure to the FTSE All-Share. Elsewhere, the Eagle Star Protected Dynamic fund offers equity exposure through active management techniques.
Open-ended CPPI can be used as a with-profits alternative
Open-ended CPPI returns a percentage of the highest Nav
Cash locking can occur in traditional CPPI
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