How crowding in trade flow can adversely affect execution costs
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.