We show that a real-time trading strategy which front-runs the anticipated forced sales by mutual funds experiencing extreme capital outflows generates an alpha of 0.5% per month during the 1990–2010 period. The abnormal return stems from selling pressure among stocks that are below the NYSE mean size and cannot be attributed to the arrival of public information. While the largest stocks also exhibit downward price pressure, their prices revert before the front-running strategy can detect it. The duration of the anticipated selling pressure has decreased from about a month in the 1990s to about two weeks in the most recent decade. Our results suggest that publicly available information of fund flows and holdings exposes mutual funds in distress to predatory trading.

We study the relationship between crowding and performance in the active mutual fund industry. Using the equity holdings overlap of 17,364 global funds, we find that funds that crowd into the same stocks underperform passive benchmark funds by 1.4% per year. The negative returns to crowding can at least in part be explained by excess demand for liquidity and the associated discount for holding liquid stocks. We show that our measure of crowding contains novel information about performance that is not reflected in other variables that describe funds’ investment environment, such as fund size and style. Our findings suggest that crowding of investment opportunities is important for understanding diminishing returns.