| Dynamic Portfolio Insurance 101 |
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| 25/07/2004 | |
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Vincent Lauwick et Franck du Plessix of Société Générale Asset Management, answer this week's 101 on Dynamic Portfolio Insurance, an alternative to the more common Constant Proportion Portfolio Insurance (CPPI) technique. What is the Dynamic Portfolio Insurance (DPI) strategy? The DPI strategy is a cushion management technique that quantifies the level of risk borne by the investment in the risky asset. It is structured as a guaranteed fund composed of both risky and non-risky assets. Risky assets can include equities, bonds, mutual funds, hedge funds, etc, while non-risky assets are generally money-market instruments. The exposure to risk depends on the volatility, the liquidity, the returns and the result of the stress test performed on the risky asset. Other factors that are taken into account include the correlation with a benchmark and the current term structure of interest rate. The allocation between the two asset classes (risky and non-risky) is actively and dynamically managed in order to maximise the expected return of the fund within the constraints imposed by the guarantee. As such, exposure to the risky asset is increased on the upside and reduced on the downside, making way for an increase in investment of the non-risky asset. A flexible methodology  source: SGAM What is the difference between a DPI and a Constant Proportion Portfolio Insurance (CPPI)? While the multiplier is fixed under a CPPI, it is variable for a DPI. A CPPI strategy is based on fixed parameters depending on market conditions at its launch date and relies on them throughout its life. Those parameters, which are aggregated in the multiplier, are variable for a DPI, following the evolution of market conditions. Both quantitative and qualitative filters are used to determine the multiplier. Quantitative filters are mainly composed of tailor-made volatility monitoring tools, including implicit and historical volatility, and on the determination of adequate ranges of adjustment of the multiplier in order to reduce structuring costs. Qualitative filters include the manager's forecast on risk/return profile of the risky asset, which determines the optimal multiplier, and is backed up by a management committee for each underlying asset. A high multiplier enables the investor to benefit from market growth but its adjustment remains expensive. A low multiplier will induce the opposite effects. The multiplier determination policy consists in underweighting it during high volatility periods and vice versa. Various volatility-related variables are used to adjust the multiplier such as current, implicit, and historical volatility. The conclusions reached following the analysis of volatility can be amplified or minimized depending on macro-economic conditions. At Société Générale AM, the maximum multiplier is determined by the results of the stress test performed on the risky asset. The optimum multiplier depends on return and volatility of the risky asset and also on the interest rate level. The adjustment of this multiplier depends on the risk aversion bound to the profile of the guaranteed product. The Multiplier  source: SGAM How does such a strategy react to interest rate movements? Guaranteed products structured with portfolio insurance mechanism prompt a reaction to interest rate movements. An interest rate swap can be carried out depending on whether the product exposure to risky assets is independent from interest rate movements and whether the mark-to-market valuation is sensitive to interest rate movements. Eventually, the implementation of flexible solutions such as a partial interest rate hedging or an interest rate dynamic management policy is possible. Is this strategy designed for clients with particular investment constraints? These capital guaranteed structures are not restricted to specific types of clients. Financial institutions, such as insurance companies, banks (for their own accounts or their distribution network), corporates, pension funds, or private individuals via their private bankers increasingly invest in these types of strategies. They provide them with a great opportunity to diversify their allocation of asset investments. The rationale behind these capital protected strategies is to offer these investors advantages such as:
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Articles of the same Serie : 101 |
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Articles of the same Topic : Portfolio management |
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