If you’ve been keeping an eye on the performance of hedge funds and mutual funds over the past 12 months or so you will have noticed that one of the themes in performance that has become clear is the underperformance of funds with the highest allocation to crowded positions.
Also see: Top hedge fund letters for Q3
A few months ago ValueWalk reported on a research note from Bank of America, which showed that the first half of 2016 was the worst first half performance for large-cap active fund managers on record (using data going back to 2003). Just 18% of large-cap funds outperformed the Russell 1000 during the first half of the year. One of the key contributing factors to this trend is the performance of crowded stocks compared to neglected stocks. According to Bank of America’s figures, during the first half of 2016 the ten most crowded stocks in the large cap funds space lagged the ten most neglected by 18 percentage points.
Another Bank of America report issued at the beginning of 2016 showed that the ten most crowded positions in the US equity markets underperformed the ten most neglected by about 7% for the period under consideration. Further, an article published in the FT citing data from Bloomberg a few months after the BoA report showed that between July 2015 and the beginning of May this year stocks in which hedge funds had the largest ownership percentage in the Russell 3000 index fell a 31%.
Looking at these figures, it is possible that if you want to outperform in today’s market, a strategy of shorting the most crowded positions and going long the most neglected stocks could be highly lucrative – of course caveat emptor.
Hedge funds love Amazon but hate Apple
UBS’s weekly Top 10 Crowded Trades report could be a great starting point for developing such a strategy. Even if you’re not interested in developing a short strategy based on crowded positions, UBS’s data is quite informative.
To compile the list of the ten most crowded positions the Swiss bank’s global quantitative equity research team aggregates positions across global active managers using institutional ownership data provided by FactSet. Using these figures analysts sum up all of the holdings in dollar value across all the active managers and calculate the weight of stocks in this active trading portfolio. This weight is then compared with the relevant equity index benchmark to form the active weight.
Using the above calculation, the most crowded overweight is Amazon.com, with an investor weight of 1.1% and an active weight of 0.2%. Following Amazon.com (NASDAQ:AMZN) is Visa, Medtronic, and United Health Group although none of these are anywhere near as crowded as Amazon.
The most underweight positions according to UBS’s analysis are Apple Inc. (NASAQ:AAPL), with an investor weight of 1% and an active weight of -0.7%; Exxon Mobil with an investor weight of 0.4% and an active weight of -0.6%; and AT&T. I
If past performance is anything to go by these stocks to buy if you want to outperform over the next few months. The full top ten overweight/underweight positions are shown below.
Also see Russell Clark warns of blow ups in crowded hedge fund trades