Journal of Investing
Annaert, J., De Ceuster M. and J. Vandenbroucke (2019), “Mind the Floor. Enhanced portfolio insurance without borrowing”, Journal of Investing. DOI 10.3905/joi.2019.1.076
In a nutshell
Rules-based portfolio insurance is popular amongst retail investors across Europe as it aims to keep interim losses within predefined boundaries. However, when offered as a fund, the strategy is typically prohibited from borrowing, which is known to hamper upside potential. The current publication develops two simple variations to the general concept to increase upside potential also in case of a no-borrowing constraint.
The no-borrowing constraint hampers upside potential in case markets perform well. In such a case, the general model would borrow money to finance a levered exposure. The variations we consider instead do something different. One variation increases the protection level up to the point where borrowing is no longer needed. The other variation increases the riskiness, and hence the expected return, of the market exposure again up to the point where borrowing is no longer needed.
An extensive simulation indicates that both variations improve the upside potential versus the status quo. The first alternative, i.e., increasing the protection level as soon as market conditions allow, increases risk-adjusted performance the most.