Sep 29, 2011
As we head to the end of the quarter, the idea of re-balancing is back making the rounds in the media and by fund companies.
When treasury bonds outperform the S&P 500, you will often get a rebalancing by large institutions. We saw this at the end of June 2011. Let’s take one type of look at how this rebalancing trade has worked in the subsequent period (quarter).
We used the 5-year treasury bond index and S&P 500 since 2000. 5-Year Bonds have outperformed stocks by at least 3 percentage points in 16 calendar quarters since 2000. In the next quarter, the S&P 500 tended to be very volatile, dropping 9 times with an average -10.6% loss. The other 7 times it rallied on average +11.0%. So in case you weren’t already thinking so --- don’t be surprised to see a big move in Q4 one way or the other.
At the end of June 2011, the story was that funds rebalanced towards stocks. We have always questioned this type of conventional wisdom and wrote instead about the opposite --- that there was relative strength in bonds. As it turns out re-balancing to stocks in June was a poor decision --- stocks suffered significant double-digit losses in Q3 2011 and treasuries continued up. Indeed, the spread between being long ~5 year Treasuries and long S&P 500 is 17.7% since June (with a few days in the quarter left).
Large funds would argue that the trade is not an attempt to be a money-making move --- just a long-term adjustment back to neutral. That is fine -- but others seem to take it and imply its a useful strategy. As we noted previously ( Rebalancing Theory & Nuances ), the value of re-balancing is not a significant source of value-add. The ‘allocate and re-balance’ conventional wisdom is in our view materially overrated by the buy-side community. The results (below) are quite wild so there isn’t a lot to be drawn bearishly either – it’s just more a matter of the fact that this does not have the characteristics of what constitutes good supporting evidence of a strong strategy (lowering risk and/or materially better return relative to that increased risk).
Here is sample of recent results:
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New Allocations Module Blog