Target Allocation Funds, Strategic Complementarities, and Market Fragility

Target allocation funds (TAFs) make predictable rebalancing trades to maintain portfolio weights across asset classes. During the COVID-19 stock market crash, TAFs sold $59 billion of bond fund shares and simultaneously purchased a similar amount of equity fund shares. We show that TAF rebalancing triggers strategic complementarity: bond mutual funds facing larger rebalancing-induced sales by TAFs experienced greater outflows from other non-TAF investors. This effect was particularly pronounced for illiquid bond funds and amplified total bond fund outflows during COVID-19 by an additional $27 billion. Rebalancing by TAFs, together with the strategic amplification by other investors, transmits equity market shocks to bond returns, accounting for 17% of the rise in stock-bond correlation over the past decade.