Tech mergers have increased crowding risks, investors say

Risk USA: Consolidation among vendors means “everyone’s looking at the exact same model”

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Rapid consolidation among sellers of risk management systems may be one reason why investors are crowding into the same trades, amplifying market swings and watering down alpha in overbought investments.   

“When I started my career… there were about a dozen different risk platforms,” said Amit Deshpande, head of fixed income quantitative investments and research at T. Rowe Price. “Today there are maybe three, four? There has been so much consolidation in how we measure our risks and our performance. Everyone’s looking at the exact same model.”

The tendency for firms to use the same risk management and alpha forecasting tools has worsened crowding, he said.

“I’m really concerned about… the consolidation of the systems in the market.”

Deshpande was speaking at the Risk USA conference in New York on November 6.  

Heavy inflows into certain strategies, such as factor investing, have raised concerns about what would happen if those strategies stumble and investors head for the exits in unison.

“All investors pretty much have the same strategies,” said Angie Elkhodiry, director of risk management at TD Asset Management. “Coupled with that we all use the same systems – whether it’s Axioma or MSCI or FactSet or Northfield – that probably takes 90% of the alpha forecasts within the global market.”

MSCI’s acquisition of RiskMetrics in 2010 combined two of the largest providers of risk management systems for the buy side. Meanwhile, Factset has made a series of acquisitions in recent years, including the purchase of performance measurement firm Bisam Technologies in 2017. 

Quantitative fund managers, which have seen the lion’s share of inflows in recent years, have blamed crowding for their relative underperformance. According to research from Bank of America, the returns of the average quant fund in the first half of 2019 lagged the Russell 1000 index by around 2%.

Deshpande said the popularity of factor investing has led many quant funds to use the same strategies. But when hordes of investors pile into the same strategies and investments, the room for profit is limited. He said further inflows into quant funds will only add to crowding risks.

“I would be concerned if we see the growth of systematic investing, especially in a particular market [scenario],” said Deshpande. “This is kind of what happened with quant trading equities in 2007 – they levelled certain positions based on some factors. I would be concerned if that happens [again] at a time when there is a paucity of liquidity.”

To protect themselves from crowding risks, asset managers need to seek out new and diverse strategies and investment ideas, according to Giuseppe Paleologo, head of enterprise risk, Millennium Management. 

“As an investor, I would just ask a competitor hedge fund where their ideas are coming from,” he says. “[Ask] whether they are sourced from independent portfolio managers or just a few sources and maybe are highly correlated.”

Regulators could also help blunt some of the risk of crowding by taking a hard look at the capacity of various strategies and funds, Elkhodiry adds. “I think regulators will probably start asking more questions about capacity and that will probably be a bridge to crowding.”

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