Sharp Decline in July and De-Grossing Trends
According to analysis from Goldman Sachs, hedge funds experienced a period of historic underperformance relative to the S&P 500 index during July. Goldman stated that the month marked one of the sharpest episodes of “de-grossing” for hedge funds over the last decade.
Ben Snider, leading the strategists at Goldman Sachs, noted that the firm’s “Hedge Fund VIP list”—which tracks popular long positions—registered its worst one-month underperformance against the S&P 500 in over 20 years of data. The report detailed that investment funds began reducing their holdings in artificial intelligence (AI) stocks.
Diversification Away from Artificial Intelligence
The struggles faced by hedge funds were directly linked to the unwinding of momentum in the AI sector. Goldman Sachs observed that funds are now diversifying their exposure away from AI, despite having been heavily invested in the technology last quarter. During that prior period, portfolio turnover reached the highest levels recorded since 2021, as funds were reportedly “all in on AI.”
The firm’s analysis highlighted that the recent AI trade caused significant fluctuations in hedge fund performance, leverage levels, and the most popular long positions. While the strong gains generated by popular AI stocks fueled record levels of crowding in the second quarter, the momentum subsequently reversed, prompting funds to trim their positions in various AI-related stocks, including many semiconductors and mega-cap companies.
Leverage Levels and Mid-August Gains
Despite the recent volatility and the decline in AI exposure, Goldman Sachs indicated that hedge fund activity remains robust relative to historical norms. While gross leverage, net leverage, and overall AI exposure have each decreased from their peaks in the second quarter, these metrics still stand above longer-term averages.
The report also noted that tech stocks were highly influential in the previous quarter, accounting for 14 of the 20 “Rising Stars” that showed the largest increases in hedge fund popularity. Nevertheless, even amidst the downturn, US equity long/short hedge funds managed to achieve a return of 10% through mid-August.
