Readers of this morning’s Wall Street Journal learned (on the front page, no less) that many of the largest investors in the U.S. equity market hold similar portfolios. “The overlap in the top 50 stockholdings between mutual funds and hedge funds…now stands at near-record levels, a study by Bank of America Merrill Lynch found.” An upshot of increased “crowding” into a small number of popular names also means that “stocks that are comparatively cheap have attracted little interest.”
Here are a few words of qualification, and perhaps comfort, to readers concerned about these issues.
- It’s impossible for every investor to overweight a stock. If mutual funds and hedge funds are overweight in aggregate, some other investors must be underweight. (Possible underweights might come from pension funds, endowments, DC schemes, individual investors, etc.) There’s no particular reason to believe that the overweighted investors are more likely to be correct than the underweighted investors. Our SPIVA results have consistently shown that the average mutual fund manager underperforms a benchmark appropriate to his investment style.
- If the market is being driven by a small number of highly-owned names, we’d expect that to show up in good results for momentum strategies. Indeed, momentum has done well this year – the S&P 500 Momentum Index (essentially the 100 top performers in the S&P 500) has outperformed its parent 500 so far in 2019 (23.5% vs. 22.1%). But the story is different for the last 12 months: Momentum has lagged (7.2% vs. 8.8% for the S&500). So concentration in fund portfolios may not be driving the market as much, or as consistently, as feared.
- Finally, concentration is not necessarily hurting the performance of relatively inexpensive stocks. Value has famously underperformed for most of the past decade, but concerns about concentration in fund holdings are new. Ironically, for the month of July, the best-performing of our factor indices is…S&P 500 Enhanced Value. Not only is Enhanced Value ahead of the S&P 500 (3.6% vs. 3.0%), both are well ahead of Momentum. Despite some investors’ concentration in glamour names, in other words, value strategies have held their own in July’s rally.
The holdings of some institutional investors may be unusually concentrated in the same stocks. Although the degree of overlap may be a statistical oddity, it should not be a cause for general concern.