Overview
Crowded trades occur when many large market participants pursue the same investment strategies causing overlapping portfolio positions. Portfolio Crowding can be especially risky when negative shocks result in forced liquidations. These “fire sales” may then cause losses for other investors following the same strategy and result in further liquidations, driving stock prices into a downward spiral.
Based on our research, we have found that portfolio crowding can also occur among factor exposures. The financial crisis’ “quant meltdown” is a classic example of this where “factor crashing” led to significant portfolio losses. Portfolio Crowding risk also affects so-called “unanchored” strategies, such as Momentum or Growth, that do not rely on a consistent or independent estimate of fundamental value.
With market activity increasingly leveraged to certain factors, determining the degree of factor crowding in a portfolio is essential to informing factor allocations and managing risk.
Aapryl’s Portfolio Crowding Module analyzes user portfolio data to identify and manage crowding. To measure and predict factor crowding we use three different methodologies:
- Pairwise correlation
- Valuation dispersion
- Fractal dimension
How it works
START A CROWDING ANALYSIS
With Crowding, you can better understand how the factors within a portfolio are behaving in the market.
DEFINE YOUR PARAMETERS
Select a product, and provide the underlying holdings, and benchmark.
ANALYZE CROWDED RESULTS
See a detailed Crowding analysis of each factor, and how they behave individually over time.
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Whitepapers
Purpose: Aapryl’s Crowding Module is designed to identify the extent to which a portfolio is subject to risk from crowded trades which can force security sales at prices substantially below the current market price.
Glossary of Terms:
- Crowded Trades – A market condition created when many market participants trade the same security or securities while employing the same or similar strategy.
- Liquidity –In the context of the Crowding Module, liquidity refers to the extent to which markets allow a security or group of securities to be bought and sold at stable prices.
- Fractal Dimension Analysis – An analysis statistically compares the short-term trading activity against the longer-term trading activity of a given stock to identify potentially crowded trades.
- Pairwise Correlation – a technique for identifying crowding risk that examines the correlation between stocks in a portfolio that have high exposure to a given factor.
- Valuation Dispersion – A technique used to identify potential crowding risk by examining the average dispersion of price to book ratios for the portions of a portfolio with the most and least exposure to a given factor.
Description of Methodology: The Crowding Module uses 3 techniques to measure crowding risk. The first, pairwise correlation, looks at the correlation of the stocks in a portfolio that are most exposed to a particular factor. A high correlation is an indication of potential crowding risk. The second, valuation dispersion, looks at the price to book ratio of the group of stocks both most and least exposed to a particular factor. A high rate of dispersion is an indication of potential crowding risk. This is particularly useful for measuring the crowding risk associated with non-valuation based factors such as momentum or growth. The final technique, fractal dimension analysis, is based on the premise that all things being equal, a stock with more short term trading has more crowding risk than a stock with less short term trading. In that context, the technique statistically compares the ratio of short-term trading against long-term trading for stocks with exposure to a particular factor. All of the techniques are calculated independently.
Information Provided: Aapryl is able to use the information generated in the crowding module to provide users with charts and graphs that contain information that they can use to assess the extent to which a portfolio is subject to crowding risk. The charts include the following:
- Pairwise Correlation Chart – Shows the median pairwise correlation across time of the stocks in a portfolio with the most exposure to the selected factor. A relatively higher correlation indicates that there is a higher risk of crowded trades.
- Valuation Dispersion Chart – Shows the dispersion of the price to book value ratio across time between the stocks that are most exposed to the selected faction and the stocks that are least exposed to the same factor. A relatively higher dispersion indicates that there is a higher risk of crowded trades.
- Fractal Dimension Chart – Shows the ratio of short-term to long-term trading across time, for a portion of the portfolio against a threshold. The ratio going above the threshold is an indication that there is relatively more crowding risk in the portfolio.
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