What it means
The investor first sets a floor, the minimum value the portfolio should never fall below, such as the amount needed to repay a promise to clients. The difference between the portfolio value and the floor is called the cushion, which is the amount that can be lost before the floor is reached.
A multiplier, chosen in advance, then decides how much of the cushion is put into the risky asset. The rule is simple: risky exposure equals the multiplier times the cushion, and the rest goes into the safe asset.
When markets rise, the cushion grows and the strategy buys more of the risky asset; when markets fall, the cushion shrinks and the strategy sells risky assets and moves into the safe one. The proportion between cushion and exposure stays constant, which is how it gets its name.
Banks and fund managers have used CPPI to build products that promise investors they will get back at least part of their capital while still offering upside. Because the strategy sells after falls and buys after rises, it behaves a little like a trend follower.
In steadily rising or steadily falling markets this works well, but in choppy markets that swing up and down it can lose money through repeated trading. The main risk is gap risk, which occurs when prices fall so fast that the portfolio cannot be rebalanced in time and the value drops below the floor.
A high multiplier increases participation in gains but makes this risk larger, because exposure is a bigger multiple of the cushion. Trading costs and the cost of delays between decisions and trades add to the shortfall.
The strategy became widely discussed after sharp market falls showed that selling into a rapid decline can itself add to the pressure. For a non-specialist, the useful idea is that protection has a price: the more insurance you want, the less upside you can reliably keep.
Any product built on CPPI should be tested against fast and choppy markets, not just smooth ones. Finance teams that meet CPPI usually do so in structured products or pension guarantees, where the floor represents a liability.
Checking the multiplier, the floor and the rebalancing frequency tells you most of what you need to judge risk.
In practice
Real-world examples.
Example
A bank offers clients a five-year note that promises to return at least 90% of the money invested. The bank runs a CPPI strategy in the background, with a floor that rises slowly towards the guaranteed amount.
Example
A pension scheme with a funding target uses CPPI for part of its assets. When markets fall, it moves automatically towards bonds to protect the funding level.
Example
A private investor with $200,000 wants growth but cannot accept losing more than $20,000. She sets a floor of $180,000, chooses a multiplier of 3 and rebalances monthly.
Formula
Calculation
Cushion = Portfolio value - Floor
Risky asset exposure = Multiplier x Cushion (capped at the portfolio value)
Safe asset holding = Portfolio value - Risky exposure
An investor has a $1,000,000 portfolio, a floor of $800,000 and a multiplier of 4.
Cushion = $1,000,000 - $800,000 = $200,000.
Risky exposure = 4 x $200,000 = $800,000, and safe holding = $1,000,000 - $800,000 = $200,000.
Now the risky asset falls 10%: it is worth $800,000 x 0.90 = $720,000, so the portfolio is $720,000 + $200,000 = $920,000.
New cushion = $920,000 - $800,000 = $120,000, new risky exposure = 4 x $120,000 = $480,000, so the strategy sells $720,000 - $480,000 = $240,000 of the risky asset and the safe holding rises to $440,000.Case study
Seen in the real world.
Falcon Rock Asset Management is an illustrative, fictional fund manager that launched a capital-protected fund with a floor of 95% of the invested amount and a multiplier of 5. In the first year the share market rose steadily and the fund captured most of the gains.
In the second year, markets fell sharply over a weekend and the fund could not sell its risky holdings until the next trading session. The portfolio dropped close to the floor, and the manager had to place almost the whole fund in the safe asset.
In this illustrative story investors kept most of their capital but missed the later market recovery, because the fund was locked in safe assets. The firm afterwards lowered the multiplier to 3 and described gap risk more clearly in its marketing.
Watch out
Common mistakes.
- Believing that CPPI guarantees the floor, when fast price gaps can push the portfolio below it.
- Choosing a high multiplier to chase returns without considering how much sharper the losses can be.
- Ignoring trading costs, which can erode returns in markets that move up and down repeatedly.
Questions
People also ask.
Is CPPI the same as buying a put option?
No, a put option is a bought contract that protects against falls, while CPPI imitates protection by trading between risky and safe assets.
What happens when the cushion reaches zero?
The portfolio is placed entirely in the safe asset and usually stays there, so it cannot participate in any recovery.
Why is a multiplier used?
It decides how aggressively the cushion is invested, with higher multipliers capturing more upside but taking more gap risk.
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