According to Goldman Sachs, hedge funds suffered significant losses as the pace of growth in AI-related company stocks slowed in July. The bank stated that the correction in the stocks of such companies forced managers to close some of their large positions, leading to one of the strongest periods of asset value decline in the past 10 years.
The report noted: "Our VIP list of hedge funds, containing the most popular long positions, experienced its worst monthly underperformance relative to the S&P 500 index in over 20 years, and July marked one of the sharpest episodes of hedge fund revenue contraction in the past decade."
According to the bank, hedge funds are currently rapidly reducing their investments in the stocks of artificial intelligence companies.
Hedge funds lost over 3% of their profits in July
Goldman Sachs claims that hedge fund performance metrics, leverage levels, and key long positions have significantly changed in connection with the shift in AI-related trading trends. Data from across Wall Street also confirms this cooling-off period.
Similarly, in early August, JPMorgan asserted that the sell-off in technology stocks erased 3% of hedge fund profits in July.
According to their analysts, fund managers were trapped in overcrowded positions in the technology sector, creating a bottleneck that prevented speculators from withdrawing cash before their profits vanished.
However, this summer downturn may be part of a predictable seasonal pattern. JPMorgan noted that since 2018, hedge funds have tended to shed losing equity positions in July. Due to this cycle, the bank hinted that traders could very well start buying technology stocks again by September, noting that managers often close trades in mid-summer only to repurchase the stocks on the market in the following months.
This year, as AI-related trading began to lose momentum, analysts remained optimistic about the prospects of AI trading and hedge fund performance. In late July, Vincent Lin, co-head of Prime Insights Analytics & Research at Global Banking & Markets, even noted that hedge funds remain deeply committed to AI technology.
At the time, he explained that the historic wave of technology stock selling appeared more like a healthy market correction amid high volatility than a loss of confidence in AI. However, as traders are now moving away from AI-related trades, it's unclear whether investors maintain an optimistic outlook on technology stocks.
Earlier this year, the war in Iran triggered a difficult March for hedge funds. However, funds quickly recovered thanks to a massive rally in chipmaker stocks led by Samsung, AMD, and SK Hynix.
The AI boom largely contributed to the excessively positive hedge fund results in Q2
Primarily, the hype around AI company stocks drove the rise in hedge fund returns in the second quarter, pushing investors to historic highs. According to Goldman Sachs, technology stocks accounted for 14 of the 20 positions on the list of fastest-growing and most popular stocks on Wall Street.
Overall, according to the analytics firm HFR, strong investment performance helped increase the industry's total assets by $409 billion, bringing the overall total to $5.6 trillion for the quarter. It was also shown that macro strategies, where hedge funds place investment bets tied to metrics like economic growth and inflation, have become the most in-demand hedge fund investment style this year.
Speaking of the excellent results of that time, Shenan Dhanani, co-executive director of Trium Capital, noted that it could become a "golden era" for funds.
However, since then, hedge fund performance has declined from those highs, although funds are still outperforming their usual averages.
The concentration of hedge fund portfolios in AI-related companies also made the July reversal more painful. Stocks of companies related to semiconductors, cloud computing, and AI infrastructure attracted significant institutional demand during the rally, leaving many fund managers exposed to risk associated with the same set of trades.
When the momentum faded, position overcrowding amplified the losses as investors rushed to reduce their risks simultaneously. This suggests that the July sell-off was not necessarily a rejection of AI as an investment theme, but rather a warning that valuations and positioning had become stretched.
"Despite the volatility, US long/short equity hedge funds have shown a return of 10% by mid-August," stated Goldman Sachs.
If hedge funds return to technology stocks in September, the recent correction may turn out to be nothing more than a summer repositioning.
However, persistent weakness in the AI-related equity market may force managers to reconsider the positions that contributed to their strong growth earlier this year.
