I know CM outperforms CPPI. But I don’t understand following statements in the solutions. CPPI : undeperform This is because under CPPI “the target equity allocation (cushion) is positively related to the level of the market”. CM : outperform This is because under CM “the target equity allocation (cushion) is unrelated to the level of the equity market”. I now what is “cushion”. But why the reasons of undeperform / outperform are as above ? Can anyone explain ?
CPPI - positively related to market because you buy more as equity inc, therefore equity exposure inc as market inc. If you buy more and stock keeps going up, you gain more. If you buy more and then the stock falls (reversal/oscillation) you lose more. CM - unrelated because you balance to original allocation of stock regardless of market. This means stocks go up, you sell to get back to original percentage. If they go down, you buy more. Does well in oscillating markets because you take money off the table when the market goes up, versus buying more or doing nothing, so when the market subsequently falls you have protected yourself.