SUPERNEWS

Macro

Morgan Stanley Warns Investors to Avoid Overcrowded Hedge Fund Trades

Morgan Stanley warns against overcrowded trades, with Avis Budget Group topping the list at over 50% hedge fund ownership.

5/23, 15:14 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
Apple Inc.
The AES Corporation
Alaska Air Group, Inc.
Amazon.com, Inc.
Bath & Body Works, Inc.
Avis Budget Group, Inc.
DXC Technology Company
Etsy, Inc.
Alphabet Inc.
Incyte Corporation
Littelfuse, Inc.
Meta Platforms, Inc.
Marvell Technology, Inc.
Microsoft Corporation
NVIDIA Corporation
TD SYNNEX Corporation
Tesla, Inc.
Universal Health Services, Inc.
article-main-img

Key Takeaway

  • Morgan Stanley warns individual investors to avoid hedge funds' overcrowded trades due to risks of overvaluation and volatility.
  • Avis Budget Group, Howard Hughes Holdings, and Incyte are among the most crowded stocks with significant hedge fund ownership.
  • Hedge funds are most overweight in consumer discretionary, industrial, and health care sectors while bearish on technology and consumer staples.

Hedge Fund Overcrowding Risks

Morgan Stanley has raised concerns about the risks associated with owning overcrowded trades, particularly those popular among hedge funds. The firm analyzed the largest 70 hedge funds based on assets under management and identified Russell 1000 stocks with the highest percentage of public float owned by these funds. According to Morgan Stanley strategists, "Crowded trades come with the risk of overvaluation and increased volatility as it may be more difficult to attract the marginal investor, while avoiding overcrowded stocks can provide investors with an opportunity to capture unrecognized value when paired with strong fundamentals."

Despite their popularity, megacap tech stocks did not make the list of overcrowded stocks due to their enormous share count, which dilutes the significance of hedge fund ownership. The analysis revealed that hedge funds were most overweight in consumer discretionary, industrial, and health care stocks last quarter, while they were most bearish on technology and consumer staples companies. Avis Budget Group emerged as the most crowded stock, with more than half of its float owned by hedge funds. Other popular names included Howard Hughes Holdings and Incyte.

Shifts in Hedge Fund Portfolios

In the last quarter, hedge funds increased their exposure to financial and tech stocks, according to Morgan Stanley's recent report. Strategist Todd Castagno noted that this shift was evident from the latest 13F filings with the Securities and Exchange Commission. "Crowded trades come with the risk of overvaluation and increased volatility as it may be more difficult to attract the marginal investor, while avoiding overcrowded stocks can provide investors with an opportunity to capture unrecognized value when paired with strong fundamentals," Castagno wrote.

Hedge funds appeared to move away from health care stocks while still maintaining significant overweight positions in the health care, consumer discretionary, and industrial sectors. Stocks that saw the largest ownership increases included Universal Health Services (2.7%), Bath & Body Works (2.5%), Alaska Air Group (1.5%), Etsy (1.3%), TPG (2.3%), DXC Technology (7.1%), and Avis Budget Group (1.6%).

AI-Driven Portfolio Adjustments

Goldman Sachs Group Inc. strategists reported that hedge funds have trimmed their holdings in megacap technology stocks while betting on a broader array of firms that will benefit from artificial intelligence. In the first quarter, funds reduced net positions in Nvidia Corp., Alphabet Inc., Amazon.com Inc., Microsoft Corp., and Meta Platforms Inc., although they added to Apple Inc. "Among the various phases of the AI trade, firms exposed to AI infrastructure investment have recently performed best and captured the most interest in our client conversations," said Ben Snider, a strategist at Goldman Sachs.

The AI buzz has propelled the S&P 500 Index to record highs this year, with investors now shifting focus to sectors that will either power AI adoption or show productivity benefits. AI infrastructure-related stocks such as Marvell Technology Inc., TD Synnex Corp., AES Corp., and Littelfuse Inc. saw the largest increase in popularity. Despite this shift, the biggest technology companies, excluding Tesla Inc., remained the most popular long positions in Goldman Sachs' hedge funds VIP list.

Street Views

  • Morgan Stanley Strategists (Cautiously Optimistic on avoiding overcrowded stocks):

    "Crowded trades come with the risk of overvaluation and increased volatility as it may be more difficult to attract the marginal investor, while avoiding overcrowded stocks can provide investors with an opportunity to capture unrecognized value when paired with strong fundamentals."