Following a steep bond selloff that left many investment portfolios out of balance, the quarter just ended on Wednesday, October 1, saw what analysts describe as outsized rebalancing action. This significant activity comes as bonds experienced a slump, sharply contrasting with stocks, which have lingered near record highs.
Investment portfolios that maintain a specific ratio of stocks and bonds are expected to have made large-scale changes to restore their target allocations. According to a report from Goldman Sachs published on Monday, U.S. pension funds alone were projected to sell $33 billion in stocks in the days surrounding the quarter's end, funneling those proceeds into bonds. This projection ranks the recently completed third quarter in the 98th percentile of all such estimates since January 2000, in absolute dollar terms, indicating one of the most substantial rebalancing events in over two decades.
Jordan Jackson, a global markets strategist at JP Morgan, stated that this quarter’s rebalancing is as significant as anything seen historically, citing higher volatility and how substantially portfolios have drifted from their target allocations. The number of managers who adjusted exposure levels this week versus those who chose to wait could influence how stocks and bonds trade around the quarter’s end, potentially boosting fixed income markets while weighing on stocks. Jackson has already observed signs of this rebalancing in mutual fund and ETF flows in recent weeks, with investors showing increased buying of bonds.
The quarterly portfolio review is a key part of the risk management discipline for many investment managers and advisors. While managers may adjust positions more frequently during volatile periods, some might opt to skip rebalancing for a quarter or two if allocations have not breached specific trigger levels.
Rebalancing into an asset class that has recently lost money, such as bonds, presents a psychological challenge for investors. The bond market consistently deteriorated throughout the quarter, resulting in the largest increase in the yield of the 10-year Treasury bond since the second quarter of 2009, even as U.S. stocks remained near their highs. Michael O’Rourke, chief markets strategist at JonesTrading, believes people "should be more aggressive than usual in rebalancing" because the selloff in Treasury bonds creates an attractive opportunity not seen in decades, contrasting with what he describes as pricey stocks. However, he expressed concern that many investors might find it tougher than usual to act.
Michael Gates, lead portfolio manager for BlackRock’s Target Allocation ETF model portfolio suite, confirmed he is overseeing rebalancing efforts. Gates is adjusting model portfolios to favor categories in both stocks and bonds that he believes offer lower risk and greater upside potential heading into the year's final months. He noted, “We’re keeping our risk in line by not allowing our models to get too overweight stocks at this stage.”
For financial advisors working with individual investors, overcoming aversion to investing more in underperforming assets can be a struggle. Mike Casey of AE Advisors in Alexandria, Virginia, highlighted the primary challenge as behavioral, stating that clients "naturally want to let winners run." The full impact of these widespread rebalancing efforts is expected to become more apparent in the early days of the fourth quarter.