Crowding is the single biggest mispriced risk for investors over a one-to-two year time horizon, according to Sasho Bogoevski, managing director, multi-asset solutions, AB.
He told delegates of the Fiduciary Investors Symposium how his firm’s research had identified crowding around stocks common in low volatility portfolios as a particular concern and how several of AB’s portfolios had been restructured as a result.
He described how stocks owned at disproportionately large volumes to others, statistically had a much higher risk of under-performance in periods of volatility or bad news. He gave the example of a crowded trade stock that reported a 5 per cent fall in revenue seeing a 30 per cent fall in value. AB research also identified crowded trades as performing well for 12-18 months before severely under-performing.
AB measures crowded trades by assessing extremes in performance over a three-year time horizon, by looking at a composite of valuation and trading volume and what Bogoevski described as the persistence of accumulation by managers.
He said the problem had become worse since the financial crisis as liquidity, particularly from brokers, had dried up due to greater capital requirements by investment banks.
Another factor for the growth in crowded trades was a growth in collective risk management by financial institutions, which tended to follow similar strategies.
He identified a trend among chief investment officers to bias their portfolio away from the fund’s ‘last big mistake’, which could lead to a concentration in another trade. Bogoevski said the position chief investment officers took was that: “If I made the last mistake again I will get fired.”
He advised investors to find a matching portfolio of uncrowded trades to offset crowded trades in their portfolios.
AB finds such matching trades by scoring all major stocks on a crowding score. By region, AB identifies emerging markets and Japan as crowded trades, while the UK and Europe are two of the least crowded trades by region. By sector healthcare, technology and consumer discretionary, are the most crowded stocks and the materials and energy sectors are the least crowded.
Bogoevski said healthcare and technology were traditionally stable assets but they had been leveraged since the global financial crisis.