U.S. Hedge Funds concentrated too high with hidden risks

High concentration of holdings is a topic often discussed by Wall Street analysts. Bank of America strategists such as Savita Subramanian, for example, routinely release a research report titled "What Are Your Neighbors Doing?" 

The reopening of the economy, several of the largest ‘stay-at-home’ stocks such as Amazon are more popular with active funds than they were a year ago, the team said in a report on Tuesday. Data compiled by Morgan Stanley's prime brokerage division underscores this. The bank’s hedge fund clients have increased their holdings of stocks they believe they buy, with the 50 most popular stocks accounting for more than 40% of their long positions last month, for the first time since 2010.

Hedge funds are known for their concentrated bets as a means of boosting performance and opening the gap with benchmark indexes. But what is unusual now is that hedge funds are pulling back from record-breaking stock market gains while more confident than ever in their stock-picking skills. Hedge funds' net holdings of software maker stocks have climbed to record highs, according to Morgan Stanley data.

Investors who have seen popular stocks suffer first in a sell-off might see it as a sign of trouble ahead. Hedge funds' concentration of holdings is so high that when they sell, the decline in stocks can be amplified.