The article “Improving Portfolio Insurance Methods – an Empirical Approach in Eu

Question

The article “Improving Portfolio Insurance Methods – an Empirical Approach in European Markets” attempts to test if portfolio insurance techniques are truly better than buy / hold strategies. There are several meaningful points to the article, including the following:

I felt the description of portfolio insurance in general was meaningful, as it created the foundation of the article. As the article states it is a hedging strategy that arises out of the asymmetric risk preferences of investors, which can be achieved through the direct purchase of a put option, static portfolio insurance, or dynamic portfolio insurance. Such portfolio insurance will ideally allow the investor to “beat the markets” or achieve a higher profit compared to buy / hold strategies.

The article then focuses on a dynamic portfolio insurance technique called Constant Proportion Portfolio Insurance (CPPI). This leads to another meaningful & significant portion of the article:

CPPI was applied to the European financial markets with a reallocation rule defined by technical analysis. The article states that “Technical analysis is a set of rules and indicators that attempt to predict the future of stocks based on the analysis of its historical evolution” (pg. 8). Specifically, the article uses a moving average in its analysis. I find this particularly interesting because historical performance is generally not a good or reliable indicator of future performance. The conclusion of the article seems to support this - portfolio insurance is dependent on market conditions as well as the path taken by underlying asset, producing results that do not appear to beat buy / hold strategies.

Finally, the following is a meaningful takeaway from the article: “The more adjustments are made in the portfolio, the closer we will meet the expected results of the strategy, but if we consider the transactions costs, the conclusions will be the opposite” (pg. 13). This shows the impact transaction costs can have on a portfolio, particularly if there is frequent rebalancing.

In not more than 3 lines, comment on the above posting.

Explanation / Answer

Answer

Rebalancing of portfolio can be done by portfolio insurance strategies to meet expected results but frequent rebalancing of portfolio will increase transactions costs on portfolio and will not produce results that will beat buy / hold strategies. So In short, buy/hold strategy is better than portfolio insurance strategies to maximise the return on investment.

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