Can traders generate attractive returns by frontrunning orders of large funds as they predictably rebalance from past winning asset classes to past losing asset classes? In their January 2025 paper entitled "The Unintended Consequences of Rebalancing", Campbell Harvey, Michele Mazzoleni and Alessandro Melone investigate market impacts of asset class rebalancing based on deviations from allocation targets or calendar schedules. Specifically, they use daily returns for E-mini S&P 500 Index (SP500) and 10-year U.S. Treasury note (T-note) futures with shortest maturities to track deviations of a 60% stocks/40% bonds (60/40) portfolio from target weights. When stocks (bonds) outperform their weights, rebalancers must sell stocks (bonds) and buy bonds (stocks) to rebalance. The larger the deviation from 60/40, the greater the likelihood and magnitude of rebalancing. They consider two rebalancing rules:
- Threshold - rebalance when portfolio weights drift a specified distance from 60/40 targets to manage trading frictions. They use an average of the rebalancings implied by regression analyses of distances in the range 0% to 2.5%.
- Calendar - rebalance at monthly intervals (the last week of each month) to meet cash flow needs.
They construct a portfolio that anticipates activity of Threshold and Calendar rebalancers by taking either a long (short) position in SP500 futures and a short (long) position in T-note futures. They rescale the Threshold signal such that the Threshold and Calendar rebalancing signals contribute roughly equal risk to the overall strategy. Using daily SP500 and T-note nearest-maturity futures prices during mid-September 1997 (E-mini inception) through mid-March 2023, they find that:
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