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A follow-the-herd mentality might come back to bite investors who buy into overcrowded trades that are popular among hedge funds, according to Morgan Stanley. In a Monday note, the bank examined the 70 largest hedge funds based on assets under management. The firm then identified stocks in the Russell 1000 with the highest percentage of public float owned by these funds, based on their most recent 13F filings. While popular trades during a bull market may benefit from hedge funds crowding into the stocks, they could also suffer the most if these pros close or cut their positions. “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,” Morgan Stanley strategists wrote in the note. Morgan Stanley found that last quarter, hedge funds increased their investments among the information technology, consumer discretionary and industrials sectors. On the other hand, they were most bearish on financials, health care, utilities and consumer staples stocks. Avis Budget Group was the most popular stock, with hedge funds owning more than half the car rental agency’s shares outstanding. Aerospace and defense stock Loar Holdings and real estate owner Howard Hughes Holdings were also two crowded stocks last quarter. Howard Hughes has recently made news due to activist investor Bill Ackman’s bids to acquire the developer. Ackman originally proposed forming a new subsidiary of Pershing Square to merge with Howard Hughes , offering $85 per share. Last week, Ackman hiked his takeover offer to $90 a share .
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