Are aggregate periodic stocks-bonds rebalancing actions of Target Date Funds (TDF), which trade against momentum, increasingly affecting U.S. stock market dynamics? In their October 2020 paper entitled “Retail Financial Innovation and Stock Market Dynamics: The Case of Target Date Funds”, flagged by a subscriber, Jonathan Parker, Antoinette Schoar and Yang Sun examine market impacts of Target Date Funds (TDFs), assets of which have grown from less than $8 billion in 2000 to more than $2.3 trillion (of roughly $21 trillion in U.S. mutual funds) in 2019. Using quarterly data on TDF holdings, monthly U.S. stock market and Vanguard Total Bond Market Index Fund (bond market) returns and monthly data for stocks held by and similar to those held by TDFs during the third quarter of 2008 through the fourth quarter of 2018 (excluding three quarters with suspect data), they find that:
- Of the dollars specified for rebalancing at the end of each quarter by explicit strategies, TDFs actually rebalance 50% during the next quarter and 45% during the subsequent quarter.
- Rebalancing is measurably contrarian. After high returns for an asset class, funds flow out of that class in proportion to TDF holdings, thereby dampening associated asset class intrinsic (time series or absolute) momentum by about 20%. Monthly autocorrelation of S&P 500 Index returns is significantly negative during 2010-2019 but not during 1986-1995 or 1996-2005.
- Compared to similar stocks, those with higher TDF ownership have lower returns after strong market performance. Specifically, after months when the U.S. stock market has 10% excess return:
- Stocks with one standard deviation (0.6%) higher share of TDF ownership have 0.24% lower return next month.
- S&P 500 Index stocks (most intensely held by TDFs) have a 1% lower return next month than similar non-index stocks. This effect does not exist prior to the rise of TDFs.
- Speculatively:
- By trading contrarily across asset classes, TDFs dampen price responses to changes in demand for stocks and bonds from other investors.
- Growth in TDFs may extinguish return anomalies attributable to trend-chasing by retail investors, such as time series momentum.
- TDFs may also dampen value investing in the case of stock price changes attributable to permanent fundamental shifts such as dividend changes.
- TDFs may propagate interest rate changes (including quantitative easing) from bond markets to stock markets.
In summary, evidence suggests that growth in TDFs is affecting U.S. stock market and individual stock returns, particularly time series momentum.
Cautions regarding findings include:
- The sample period (10 years) is short for assessing secular trends in asset class behaviors.
- The paper does not devise/test strategies for exploiting findings.
