What Alleviates Crowding in Factor Investing?

70 Pages Posted: 10 Jun 2019 Last revised: 27 Apr 2020

See all articles by Victor DeMiguel

Victor DeMiguel

London Business School

Alberto Martin-Utrera

New Jersey Institute of Technology

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Date Written: May 9, 2019

Abstract

Smart beta is a low-cost approach to factor investing that exploits common firm characteristics. The growing number of smart-beta providers raises concerns that crowding may increase price-impact costs and erode profits. We show crowding is alleviated by trading diversification--other institutions exploit strategies that, when implemented concurrently with the smart-beta strategy, reduce its price impact. Surprisingly, trading diversification occurs even when the trades of the other strategies are not negatively correlated with smart-beta trades. We show theoretically and empirically that, unlike the effect of competition in smart-beta, competition among institutions exploiting other strategies increases smart-beta profits because of trading diversification.

Keywords: financial institutions, capacity of quantitative strategies, price impact, competition, liquidity provision

JEL Classification: G11, G12, G23, L11

Suggested Citation

DeMiguel, Victor and Martin-Utrera, Alberto and Uppal, Raman, What Alleviates Crowding in Factor Investing? (May 9, 2019). Available at SSRN: https://ssrn.com/abstract=3392875 or http://dx.doi.org/10.2139/ssrn.3392875

Victor DeMiguel (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Alberto Martin-Utrera

New Jersey Institute of Technology ( email )

University Heights
Newark, NJ 07102
United States

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

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