Bond Selloff Drives Outsized Rebalancing at Quarter's End for Investors
Quarter-End Portfolio Rebalancing Amid Bond Market Volatility
(Corrects JP Morgan to JP Morgan Asset Management in paragraph 3)
By Suzanne McGee
Unprecedented Portfolio Adjustments Triggered by Bond Selloff
PROVIDENCE, Rhode Island, Oct 1 (Reuters) - Investors usually treat quarter-end rebalancing of their portfolios as a routine chore, but the quarter just ended on Wednesday is expected to have seen outsized action after a steep bond selloff left many portfolios out of whack, analysts said.
The slump in bonds in the past quarter is in sharp contrast to stocks, which have been lingering near record highs. Investment portfolios adhering to a specific ratio of stocks and bonds are therefore expected to have undertaken large-scale portfolio changes to get back on track.
"I do think this quarter will be as significant a rebalancing as anything we’ve seen historically because volatility is higher and because of how significant the drift away from target allocations has been," said Jordan Jackson, global markets strategist at JP Morgan Asset Management.
Impact on Market Dynamics
How many managers reset exposure levels this week — and how many find reasons to wait — can shape how stocks and bonds trade around the quarter's end, potentially boosting fixed income markets and weighing on stocks.
According to a report from Goldman Sachs published on Monday, US pension funds alone were expected to sell $33 billion in stocks in the days around the end of the quarter, simply to bring their target allocations in line, while funneling the proceeds into bonds.
Those projections rank the just-completed third quarter in the 98th percentile of all such estimates, in absolute dollar terms, going back to January 2000. That means that in only 2% of quarters did the estimates top $33 billion.
The full effects of the rebalancing are likely to become more visible in the early days of the fourth quarter.
Signs of Rebalancing in Fund Flows
While it is hard to track those flows in real time, Jackson said he has spotted signs of rebalancing in mutual fund and ETF flows in recent weeks, with investors emerging as bigger buyers of bonds.
Rebalancing Strategies and Behavioral Challenges
The quarterly portfolio review is part of the risk management discipline of many investment managers and advisers both large and small. When markets are moving violently, they can adjust positions more frequently, while some may skip rebalancing for a quarter or two as long as allocations have not breached specific trigger levels.
"People should be more aggressive than usual in rebalancing, because the selloff in Treasury bonds is creating a more attractive opportunity than we've seen in decades, while stocks look pretty pricey," said Michael O'Rourke, chief markets strategist at JonesTrading. "But I worry that a lot of them will find it tougher than usual."
Time to Buy Bonds?
Investors and analysts acknowledge that rebalancing into a money-losing asset class is always a psychological struggle. The bond market deteriorated steadily as the quarter progressed, sparking the largest increase in the yield of the 10-year Treasury bond since the second quarter of 2009. US stocks, meanwhile, hovered near their highs.
Portfolio Managers’ Approaches
Michael Gates, lead portfolio manager for BlackRock’s Target Allocation ETF model portfolio suite, said he is overseeing some rebalancing, tilting model portfolios in favor of categories in stocks and bonds that he feels offer lower risk and greater upside moving into the final months of the year.
"We're keeping our risk in line by not allowing our models to get too overweight stocks at this stage," Gates said.
Advisers Face Behavioral Hurdles
For financial advisers working with individual investors, it can sometimes be a battle to overcome their aversion to putting more money into an underperforming asset.
"The biggest challenge is behavioral," said Mike Casey, of AE Advisors in Alexandria, Virginia. "Clients naturally want to let winners run."
(Reporting by Suzanne McGee, additional reporting by Laura Matthews; Editing by Megan Davies and Edmund Klamann)
