These stocks may be crowded … But it doesn’t mean they are riskier than they used to be

The Wall Street Journal recently did a piece on stocks that have the most investors crowding into them, citing a report from analysts at Bernstein and an analysis from Bank of America Merrill Lynch. (See “Investors Favor Fewer Stocks, Leading to Crowded Trades”, The Wall Street Journal, July 29.) They listed 19 stocks that comprised some of the market’s most crowded trades, and we thought a risk analysis of these stocks, compared with the broader market, would be interesting.

Cumulative Active Return, Most Crowded Stocks vs. Russell 1000

We subsequently created a portfolio by equally weighting the 19 stocks, and that portfolio has indeed outperformed the market by a wide margin this year, mainly as a result of the group’s factor and sector exposures. Attribution of year-to-date performance shows that the outperformance of the group of stocks relative to the large-cap US market, as measured by the Russell 1000, was helped most by its sector exposures (mainly an overweight of more than 22% in Information Technology). Several style factor exposures also drove the outperformance, most notably positive exposures to Growth, Medium-Term Momentum, Market Sensitivity and Size, and negative exposures to Value and Volatility. Specific return contributed 1% to the outperformance.

Attribution of "Crowded" Portfolio, Year-to-Date Through July 26

Source: Wall Street Journal, FTSE Russell, Axioma

As this group of stocks surged and investors crowded in, we expected risk would rise, too. But after looking at this through four different lenses, we found that, contrary to our expectation, their risk was steady or down throughout this year.

  • While the “Crowded” portfolio had higher total risk than the benchmark (unsurprising given how few stocks were included and the high incidence of Technology names), its risk fell along with that of the Russell 1000.
  • The portfolio’s beta fell from a peak of 1.16 in February to 1.11 most recently.
  • The active risk of the portfolio versus the Russell 1000 was down from over 7% to about 6%.
  • And while this group of stocks has fared well, their aggregate weight in the Russell 1000 has not really increased, and, more surprisingly, nor has their contribution to the risk of the benchmark. Whereas they do contribute more to risk than one would expect given their weight, which indicates that overweighting these stocks in a portfolio would add to its active risk, that gap has not changed very much even as the stocks have soared.

We therefore conclude that while these stocks may be more crowded than their peers, they seem to have experienced a general decline in volatility, in terms of active risk and beta. Total risk has declined, but it has for the market as well, and the gap has remained relatively steady. In addition, these stocks’ contribution to index volatility has also seen little change. If investors remain interested in these names, they may not need to worry too much that they will drive heightened risk in their portfolios. Of course, that could well change if investors decide they want to exit these stocks and crowd into different ones…

Crowded Portfolio vs. Russell 1000

Source: Wall Street Journal, FTSE Russell, Axioma

Melissa R. Brown, CFA

As Managing Director of Applied Research, Melissa Brown generates unique insights into risk trends by consolidating and analyzing the vast amount of data on market and portfolio risk maintained by Axioma. Brown’s perspectives help both clients and prospects to better understand and adapt to the constantly changing risk environment.