Hedge funds endured their sharpest monthly underperformance against the S&P 500 in more than two decades in July, as a reversal in AI stocks forced managers to cut positions and reduce exposure to some of the market’s most crowded trades, according to a report by CNBC citing data from Goldman Sachs.
The bank said its basket of the stocks most widely held by hedge funds suffered its worst one-month performance relative to the S&P 500 in more than 20 years of data.
The reversal also triggered one of the most pronounced episodes of hedge fund de-grossing in the past decade, with managers cutting positions across a range of AI-related stocks, including semiconductor companies and several mega-cap technology names.
The sharp change in positioning follows a period in which hedge funds had embraced the AI theme aggressively.
Hedge funds entered the second quarter heavily positioned for continued gains in artificial intelligence, with portfolio turnover reaching its highest level since 2021, according to Goldman.
The strategy initially paid off. Popular AI-linked stocks helped drive strong hedge fund returns during the second quarter, while crowding in widely held positions reached record levels.
Technology stocks accounted for 14 of the 20 so-called Rising Stars — companies that recorded the biggest increases in hedge fund ownership during the quarter.
The subsequent reversal has forced managers to reassess those positions.
Goldman said hedge funds had begun diversifying away from AI as the trade lost momentum, with managers reducing exposure to some of the semiconductor stocks and mega-cap technology companies that had previously been among their preferred investments.
Hedge funds have reduced gross leverage, net leverage and overall AI exposure from the levels reached during the second quarter.
Even after the pullback, however, each remains above its longer-term average, suggesting that managers have not completely abandoned risk-taking.
Goldman said the recent swings in performance and positioning demonstrated how closely hedge fund returns have become linked to the fortunes of the AI trade.
The July sell-off was therefore not simply a poor month for a handful of technology-focused managers. It represented a broader unwinding of one of the most popular investment themes across the hedge fund industry.
Despite the setback, US equity long-short hedge funds remained firmly profitable for the year. Goldman estimated that the strategy had returned about 10% through the middle of August.
