(Bloomberg) -- The turmoil in global equities has spurred a wave of deleveraging among volatility-targeting funds that's set to unleash $225 billion of equity sales in the coming days, according to Barclays Plc.
Some $500 billion of assets are tied to funds that target a given level of volatility -- two-thirds of which are traded by algorithms that look poised to divest after Monday's eruption of turbulence, according to the British bank. Volatility-targeting investment strategies have become popular in recent years, spurred by the market calm and equity bull run.
“As market selloffs and expected volatility increase, these funds decrease their leverage to equities,” strategists led by Maneesh Deshpande wrote in a Tuesday note. Although the specific inputs aren't known and differ between managers, the leverage taken by quantitative funds in the run-up to the global selloff "was likely quite high given the low levels of volatility."
Volatility-control funds with a 12 percent target, 30 percent exposure to bonds and a variable allocation to U.S. stocks would be selling equity futures totaling 15 percent of their assets, according to Goldman Sachs Group Inc. research. That “may pressure equities in the coming days, though these flows can be offset by corporate buybacks and fundamental investors,” strategists led by John Marshall wrote in a Tuesday note.
JPMorgan strategists see $100 billion in U.S. equity outflows from systematic strategies.
The VIX traded as high as 50.3 on Tuesday before easing.
A gauge that tracks returns of an S&P 500-based strategy adjusting exposure to target 10 percent volatility tumbled the most in 11 years on Monday. It wiped out most of the year-to-date gains as the Cboe Volatility Index surged to its highest level since August 2015.
“We estimate that the leverage likely dropped to ~0.5 which would trigger a net selling of ~$225b over the next few days,” the strategists conclude.
To contact the reporter on this story: Sid Verma in London at sverma100@bloomberg.net.
To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Joanna Ossinger, Cecile Vannucci
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