AllianceBernstein: “Beware of crowding risk for stocks”
When it comes to stocks, investors often overlook the risks of getting trapped with too many people in an untenable position and this is a dangerous omission from the standard investment playbook, according to Vadim Zlotnikov, chief market strategist for AllianceBernstein.
“Nobody likes to be stuck for too long on a crowded bus or train especially when it’s time to get off. Our research shows that poor performance of crowded large-cap stocks in the US is clearly coincident with periods of outflows from active management,” he said.
According to the strategist, the concept of crowding can be easily misunderstood.
“You might mistake it for momentum because crowded stocks tend to have outperformed. Some may confuse it with growth, as crowded stocks often have higher valuations and expectations. We believe that a quantitative crowding indicator can help avoid the risk of the so-called winner’s curse, when widely shared optimism about an investment’s desirability can create an illiquid situation just when you want out,” he said.
Four factors can capture key aspects of crowding and differ from traditional growth-stock definitions according to AllianceBernstein: breadth of ownership, consecutive net institutional purchases, volumes and valuation and sell-dide popularity.
Each of the four measures showed substantial underperformance by crowded stocks during the past four years, and more broadly, during months of outflows from active management.
During the same periods, uncrowded stocks tended to outperform as passive funds and exchange-traded funds (ETFs) became more popular.
These trends are probably the result of the extreme risk-on, risk-off environment of recent years, as derisking pressures, episodic illiquidity during big market moves and increased tail-hedging all promoted crowd formation.
“Based on these factors, we found that crowded US large-cap stocks performed especially poorly over the past four years, when there were significant outflows from active management and growing emphasis on risk management,” Zlotnikov said.
He warned: “It’s time for investors to pay more attention to crowded trades and know how to avoid them in certain market conditions. Until flows into active management improve, we favor highly rated uncrowded stocks and would exercise caution in adding too much exposure to crowded stocks-especially those with poor fundamentals.”