In the second quarter, long-only funds (LOs) made significant moves by increasing their exposure to Communication Services, boosting their relative weight in the sector by five percentage points to over 30% overweight, according to a note from Bank of America on Friday.
In its active managers holding update note, BofA says the shift underscores a growing confidence in a sector that was already considered “the most crowded” as LOs sought to capitalize on its perceived stability.
To fund this shift, LOs are said to have notably reduced their positions in cyclical sectors, particularly in Materials and Energy, with exposure decreasing by 4 and 3 percentage points, respectively.
The reduction in Discretionary stocks, down by four percentage points, is seen as further highlighting ongoing concerns about consumer resilience, particularly as economic indicators suggest a possible downturn.
Bank of America’s analysis also reveals that despite these strategic reallocations, active managers have not shown a strong appetite for taking on positive tail risk.
The firm’s US Regime Indicator and Global Wave both indicated a deteriorating economic environment in July, suggesting a potential shift from the current Recovery phase back to a Downturn.
This caution is reflected in factor tilts favoring Low Beta stocks, as well as an uptick in cash levels, signaling rising risk aversion among active managers.
Interestingly, the “least crowded stocks were spared during the summer sell-off,” said Bank of America.
“A strategy of going long the 25 least crowded stocks and short the 25 most crowded stocks (based on both LOs’ relative weight and ownership breadth) would have generated >8ppt of alpha during the S&P 500’s peak-to-trough decline,” they added.
Overall, the widening market breadth, observed since June, bodes well for active managers, particularly those who have been grappling with the dominance of mega-cap stocks.
“Healthier breadth is a positive for PMs, who over the past year have been faced with the choice of either increasing their concentration risk or heavily underweighting recent leadership,” concludes BofA. “We expect the rotation to continue, favoring the equal-weight index.”
