Aside from new buyers coming to the market looking to call the bottom and short-sellers covering their positions, there may be another reason why equity markets will be rallying into this month’s end – balanced mutual funds.

A typical balanced mutual fund invests 60% of its assets in bonds and money market instruments, and 40% of its assets in equities. The intention of these funds is to keep the 60/40 split as steady as possible in order to maintain this balanced approach to investing. So as markets move, weightings may become out of whack, requiring the fund to rebalance in order to get back to the original 40/60 weighting. And nearly all do this on a monthly basis… at the end of the month.

So what happens this month when equity markets are down 27% (in the case of the S&P 500) and long-term bonds are up ~2-3% (using TLT, the 20+ year bond iShare in the US as a proxy) for the month? The funds are now far from balanced. Their proportionate share of equity exposure is now well below the target. These funds have to go buy equities to bring their exposure back to 40% (or whatever their target split is).

To put this in perspective, for a balanced fund with $1 billion of assets under management targeting a 40% weighting to equities, a drop of 27% in the value of the fund’s equity portion would require a purchase of over $60 million in equities in order to rebalance. And in aggregate, balanced funds in the US likely managed upwards of $100 billion.

Balanced funds certainly don’t all rebalance right on the last day of the month. The portfolio managers have discretion as to when they begin executing the rebalancing near the end of the month. So some managers may begin rebalancing in the days leading up to October 31. However, its likely most have waited to buy as equity markets have continued to tank.

Over the last two days we’ve seen equity markets rally higher. Could this be because of bottom-feeding value players? Sure. Could it also be because of traders covering their short positions? Maybe, but we’re now in the second day of the rally, so I would guess short covering has already passed. Finally, is it possible that balanced funds are having an impact? It’s very possible, and if they’re ever going to have an impact, it’ll be this month, given we haven’t had a month like this past October in a very long time.

If this is a phenomenon due to the rebalancing of balanced funds, then be careful come November 1… the buying may end abruptly.