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Latest trade: Buying ‘neglected’ names

Just as there could be hidden value in a neglected home in disrepair that most people would never consider buying, so is there value in stocks that money managers commit little cash to.

The equity team at Bank of America Merrill Lynch has identified a winning 2016 trade in what has been a relatively flat year for the U.S. stock market. Own “neglected” stocks, or the 10 most “underweighted” names in the portfolios of active fund managers. Sell “crowded” trades, or the 10 most overweighted stocks.

In trading thru May 19, the basket of the 10 most neglected stocks posted a positive return of 8.2%, or 9.5 percentage points better than the 1.3% decline for the top 10 most-favored stocks in money managers’ portfolios.

A reason for the discrepancy is that investment flows from active funds to passive ones, or index funds that track a basket of stocks have accelerated, creating pockets of value, a report by Savita Subramanian, equity and quantitative strategist at BofA Merrill Lynch, found.

“One quantitative factor that has worked unusually well for the last several years is a simple positioning trade: selling the 10 most overweight stocks and buying the 10 most underweight stocks by active managers,” she wrote.

BofA data show the threemonth relative performance of stocks that were the most over-owned (or those with three times the exposure compared to a benchmark index) was far worse than stocks that had weightings more in line with the index.