Systematic volatility control funds have pushed their equity exposure to the 98th percentile since 2010, leaving them with little room to keep buying and exposed to forced selling if market turbulence returns. Barclays' Stefano Pascale says even a mild rise in volatility could cause a significant exposure unwind given how the S&P 500 has rallied this year.
Volatility control funds — systematic strategies that buy equities when markets are calm and sell when they turn turbulent — have pushed their equity allocations to the 98th percentile, according to Deutsche Bank data, meaning they have been higher only about 2% of the time since 2010. The buying came as the S&P 500 rose 12% for the year, propelled by robust earnings and spending on AI infrastructure.
As volatility petered out, these strategies had to keep ramping up risk-taking. But that has left them with limited room to add further equity exposure and more vulnerable to any market shock. According to Barclays: "Volatility control exposure is historically stretched", said Stefano Pascale, the bank's head of US equity derivatives research.
Asymmetric risk if volatility spikes
Vol control strategies are run by insurers, annuity issuers, and asset managers, with total assets estimated at $300 billion to $500 billion across various bank estimates — small next to the $66 trillion value of the S&P 500 itself. Still, analysts say selling by these funds tends to exacerbate volatility beyond what their size would suggest.
Pascale illustrated the reaction function using a typical 10%-vol-target fund: with equity allocation currently around 88%, a further drop in volatility that pushed that allocation to 99% could require an additional $25 billion in buying. A mildly bearish scenario, however, could push that same fund's allocation below 40%, entailing the sale of more than $100 billion in equities.
Trend-following funds face a similar squeeze
Commodity Trading Advisors, trend-following funds that scale exposure based on price momentum and volatility, sit at a historically high 82nd percentile in equity allocation, Deutsche Bank data show. Like vol control funds, they have already priced in much of the recent momentum, leaving limited scope to add further exposure.
A UBS estimate from late August suggested a two-sigma move — a rare swing that happens about 5% of the time — could trigger five times as much selling on the downside as buying on the upside. With US midterm elections five weeks away, Barclays analysts said the precarious positioning in these systematic strategies is a risk that is becoming more relevant.
Source: Investing.com
Trading involves risk.
Risk Disclaimer
