Volatility control funds near record equity exposure, raising selloff risk
SPY•Volatility control funds’ equity allocations have reached the 98th percentile since 2010, Deutsche Bank data shows. Barclays estimates a mild volatility rise could prompt more than $100 billion in equity selling.
1. Exposure near historic highs
The stock market rally has pushed volatility control funds’ equity allocations to the 98th percentile, meaning they have been higher only about 2% of the time since 2010, according to Deutsche Bank data. These strategies typically buy equities when markets are calm and sell when turbulence rises.
2. Potential for forced selling
Barclays’ model for a typical 10%-volatility-target fund puts its current equity allocation around 88%. A further decline in volatility could push that allocation to 99%, requiring an estimated $25 billion in additional buying; in a mildly bearish scenario, allocation could fall below 40%, entailing more than $100 billion in equity selling. Barclays’ Stefano Pascale said even a mild rise in volatility could cause a significant unwind.
3. Other strategies also exposed
Trend-following CTAs’ equity allocations are at the 82nd percentile, according to Deutsche Bank. A UBS estimate from late August suggests a two-sigma move could trigger five times as much selling on the downside as buying on the upside. Barclays analysts said systematic fund positioning appears increasingly relevant with the U.S. midterm elections five weeks away.
