Abstract
In <b><i>Questioning the Wisdom of Crowds to Design Portfolio Diversification Strategies</i></b>, from the Winter 2023 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Vadim Zlotnikov</b>, <b>Igor Halperin</b>, <b>Lisa Huang</b>, <b>Cathy Pena</b> (all of <b>Fidelity</b>), and <b>Mikhail Stukalo</b> (of <b>Gainy</b>, a fintech startup), develop a diversification strategy based on measures of crowdedness. They design a portfolio with the positive characteristics of uncrowded stocks that also harvests the skill of active managers. They create a measure of crowdedness using holdings data on active managers. Stocks can become crowded based on conviction, reflecting manager skill. But they also can become crowded due to a consensus view, which leads to problematic characteristics; crowded stocks can exhibit negatively skewed returns with high forward-looking volatility. The authors also construct a long–short portfolio based on two different measures of crowdedness. The portfolio is beta-neutral and can be used to improve the Sharpe ratio of a 60/40 portfolio by dampening volatility. Maintaining smart money investors’ insights, the equity component does not sacrifice returns, as other defensive strategies do.
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