TRH better choice than CPPI for investors
Tail risk hedging (TRH) is a better choice for most investors today than constant proportion portfolio insurance (CPPI) when it comes to protecting portfolio value, according to PIMCO research.
According to its study, both approaches had merit, however PIMCO’s historical analysis suggests that TRH may be preferred strategy given low interest rates and low implied volatility in equity markets.
In an environment of low interest rates, CPPI structures had very little time during a sell-off before they were forced to de-risk, the study said.
It also found that the cost of tail risk hedging was low, which combined with a strong historical performance in a crisis and the ability to participate in a rebound, constituted a better choice for investors today.
“In post-crisis periods, CPPI lost its return advantage over TRH,” the study said.
“Intuitively, this may be because lower interest rates increase the amount deposited in the CPPI safety account, reducing the loss buffer in the risk account.
“A substantial sell-off therefore causes the structure to de-risk. And as we have seen, if the market subsequently rebounds, then CPPI will likely lag due to its path-dependent nature.”
“Given these patterns, today’s low interest rates and muted equity volatility suggest that investors looking to defend gains in their portfolios may find TRH more appealing.
At the same time, the study found that although TRH outperformed during the global financial crisis (GFC) its performance was much weaker during the tech bubble.
AUTHOR
Oksana Patron
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