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Crowd Positioning: The Fourth Dimension in Investment Evaluation

Citi Multi Asset Research analysts Stephen Antczak, Jung Lee and Swati Verma track what the competition is doing in their research series “Where’s the Crowd?’ Part 1 (How to find out what the other guy is doing) was published on October 8. On October 21 the authors go a step ahead and take their methodology for a test drive, looking at what is crowded now – across both sectors and single names. We look at their analysis of Bank of America Corp (NYSE:BAC).

Crowd positioning: The Fourth Dimension

The authors state that after fundamentals, technicals and valuations, investment evaluation must also take into account a fourth factor: how other investors are positioned in that sector or stock.

The main reason for this is risk. In recent years the investor base has become more homogenous, and similar positioning (for example long only) across the markets has increased the risk for participants in case an unexpected event triggers large-scale unwinding.

This is also recognized by the Office of Financial Research (OFR), which recently conducted a study on the activities of asset management firms under the Dodd-Frank Act on whether they presented systemic risk. An extract: “Some asset managers may also crowd or “herd” into popular asset classes or securities regardless of the size or liquidity of those asset classes or securities. These behaviors could contribute to increases in asset prices, as well as magnify market volatility and distress if the markets, or particular market segments, face a sudden shock.”

An investment analyst must also therefore take into account whether, and how much, a sector or issue is crowded as a part of the overall analysis.

How to find out what the other guy is doing?

Citi have a four-step framework for assessing the positioning of the crowd. The methodology involves analyzing unusual trade flows, their direction (trend continuation or reversal?), the impact of unwinding and lastly, the probability of an unwinding.

Crowd trades

Test run of the methodology

The authors apply the framework to Bank of America Corp (NYSE:BAC) in the example shown below.

Crowd Bank of america

Though Bank of America Corp (NYSE:BAC) is “crowded” as per the above analysis, the authors do not recommend selling it, being a fundamentally sound investment. However, “…it may make sense to take profits a bit sooner than one normally might otherwise,” say the authors.

A more detailed presentation of crowded sectors and stocks would be available in Part 2 of the study.