By connecting stocks through common active mutual fund ownership, we forecast
cross-sectional variation in return covariance, controlling for similarity in style (in-
dustry, size, value, and momentum), the extent of common analyst coverage, and
other pair characteristics. We argue this covariance is due to contagion based on re-
turn decomposition evidence, cross-sectional heterogeneity in the extent of the effect,
and the magnitude of average abnormal returns to a cross-stock reversal trading strat-
egy exploiting information in these connections. We show that the typical long/short
hedge fund covaries negatively with this strategy suggesting that hedge funds may
potentially exacerbate the price dislocation we document.