Investors consider rebalancing quirks

• Diverging performance is the latest quirk of a strategy that has become a focal point of the options-trading world

Investors seeking shelter from the stock storm by funnelling cash into one of Wall Street’s most popular options-based strategies are getting a lesson on how the calendar and a little luck can hold sway when it comes to portfolio performance.

Investors seeking shelter from the stock storm by funnelling cash into one of Wall Street’s most popular options-based strategies are getting a lesson on how the calendar and a little luck can hold sway when it comes to portfolio performance.

A set of matching hedgedequity products from JPMorgan Asset Management, which deploy derivatives to protect against sharp market drawdowns, are posting varying returns in 2022 even as they pursue identical investing styles.

Thanks to staggered rebalancing dates and the twists and turns of the S&P 500 this year, the $15bn JPMorgan Hedged Equity Fund (JHEQX) lost 12% while one younger sibling (JHQTX) is down 18%. Another (JHQDX) is losing 13%.

While all three funds are beating the US benchmark as promised, investors in JHQTX in particular are enduring worse 2022 returns than their peers thanks to nothing more than luck-of-the-draw on reset dates.

The diverging performance is the latest quirk of a strategy that has become a focal point of the options-trading world.

The rebalance of the main fund — next occurring on Friday — is a must-watch market event because of the huge and wellknown trades it makes every quarter. Many say it capable of disrupting derivatives and their underlying equities. JPMorgan Asset Management created the two younger funds with different reset dates to spread out the effects.

Since then, the pair grew to a combined $8bn, taking total assets across the strategy to more than $23bn.

“By rolling on a quarterly basis or really any schedule, they’re locking in this path dependency, both based on when they rebalance and what the market’s giving them,” said Corey Hoffstein, co-founder of asset manager Newfound Research, who pointed out the trend on Twitter and has studied the influence of rebalance schedules on strategy returns.

A JPMorgan Asset Management spokesperson declined to say. The JPMorgan products all defend their equity holdings with a put-spread collar trade.

That means they buy protective puts and fund them by selling bullish calls as well as an even more bearish put.

The effectiveness of the protection depends on the level of the benchmark US gauge when the contracts expire.

From the end of March, the main fund was protected from losses that were ranging from 5% to 20%.

As it rebalanced on June 30, the S&P 500 was down about 16% — so the puts it owned successfully cushioned against the sell-off.

But it was a different story for the JPMorgan Hedged Equity 3 Fund, which rebalanced on May 31 with the same levels of protection. By then the S&P 500 had already plunged 13% from its peak, and by the time of the next rebalance at end-August it had only dropped another 4% — meaning the puts were out-ofthe-money and offered no protection.

The divergent performance of matching products “speaks to the need for hands-on management” when running this type of strategy, said Pat Hennessy, head trader at IPS Strategic Capital, which also offers derivativebased hedging strategies.

To Hoffstein, it shows a money manager might be better off spreading out their rebalance trades so that it ends up with options at a range of strike prices and dates. To smooth out their exposure, an investor can put their money in all three products, he said.

A fund from Simplify Asset Management, the Simplify Hedged Equity ETF, employs an equivalent approach, with a ladder of options across three months. The $66m product is down about 10% this year.

Still, rebalancing once a month or quarter has the benefits of transparency and simplicity. And much depends on an investor’s holding period.

In theory, performance should even out over a longer horizon, while another time measurement could just as easily have shown the original fund lagging. As things stand, JHEQX’s puts appear to be out-of-themoney before the Friday reset. In a 2020 paper, Hoffstein and his co-authors found that varying reconstitution schedules can lead to more than 100-basis point annualised spread in performance for quantitative factor portfolios. On top of that, trading all at once for a fund the size of JPMorgan’s may also prove to be costlier as it may move prices against it.

“The rebalance timing luck stuff is totally independent of being front-run,” said Hoffstein. “But the front-run problem makes it worse.”