Packed in like sardines: how crowding in trade flow can adversely affect execution costs

26 April 2019

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Alternative Risk Premium strategies have received investor attention over the past few years and consequentially assets allocated to these strategies have increased.

This, in turn, has given rise to a fear of concentration, most commonly referred to as crowding. Moreover, a spell of modest returns – especially in 2018 – has led investors to question the efficacy of these strategies, with the blame for sub-par performance often ascribed to crowding.

Investors are not only concerned that a crowded market or strategy results in deteriorating returns as participants chase the same opportunities, but that sell-off risk, when large positions in the same assets are liquidated at the same time, also increases.

In this note, we instead discuss a simple, yet real example of how crowding in trade flow may result in deteriorating returns by increasing the cost of execution. We show how, with a dedicated and bespoke execution solution, we can reduce some of the risk that arises from participating in a crowded trade.

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