Following the Crowd Can Be Expensive: How Crowded Trading Can Shake Up Markets

Crowd-Following Mentality Can Be a Double-Edged Sword for Traders, Says Morgan Stanley

The tendency to follow the crowd can be risky for traders who invest in overcrowded trades popular among hedge funds, according to Morgan Stanley.

In a Monday note, the bank analyzed the 70 largest hedge funds based on their assets under management. It then identified Russell 1000 stocks with the highest percentage of public float owned by these funds, based on their latest 13F filings.

While popular trades can benefit from hedge fund accumulation during a bull market, they are also the most vulnerable if these professionals close or reduce their positions.

“Overcrowded trades carry the risk of overvaluation and increased volatility, as attracting additional investors may become more difficult. On the other hand, avoiding such stocks can give traders an opportunity to capture hidden value when combined with strong fundamentals,” Morgan Stanley strategists wrote.

Morgan Stanley found that in the last quarter, hedge funds increased their investments in technology, consumer goods, and industrial sectors. Meanwhile, they were most bearish on stocks in the financial, healthcare, utilities, and consumer sectors.

The most popular stock among hedge funds was Avis Budget Group, with hedge funds owning more than half of the company’s shares. Stocks in the aerospace and defense industry, such as Loar Holdings, and real estate company Howard Hughes Holdings, were also among the most overcrowded in the last quarter.

Howard Hughes Holdings recently made headlines due to activist investor Bill Ackman’s acquisition attempts. Initially, Ackman proposed creating a new subsidiary of Pershing Square to merge with Howard Hughes, offering $85 per share. Last week, he raised his bid to $90 per share.