Federal Reserve rate rises may have boosted constant proportion portfolio insurance notes in the U.S., protecting them from last month's equity volatility. Indexed hedge fund-of-funds reported drops of over 2% last month for strategies such as event-driven and equity long short.
There was concern last month this volatility and gaps in hedge fund-of-funds' value could cause some CPPI structures to deleverage, locking investors' cash into the lower-yielding investment. But, structurers said older-style CPPI strategies are exposed to interest rates, splitting investors' cash between a bond investment and a riskier asset class, such as a hedge fund-of-funds or equity basket note. Rising rates have boosted the value of the 'safe' investment, which increases the amount of investors' capital the structuring house can leverage and expose to a riskier asset class.
"Certainly choppiness in fund returns will require CPPI rebalancing, but you have some offset as interest rates rise," explained a structurer in New York. The other positive news for more recent CPPI notes is that more and more deals have been structured with an allowance for the volatility of the underlying. For example, instead of the risky allocation being channeled directly into a fund or equity basket, it is used to buy an option on the underlying. "With this optionality, [underlying] volatility is priced in to the product upfront," added the structurer.