Goldman Sachs: Hedge funds see historic underperformance as AI momentum cools

Hedge funds struggled to a historic extent as AI momentum unwound in July, according to Goldman Sachs.

"Our Hedge Fund VIP list of the most popular long positions suffered its worst 1-month underperformance vs. the S&P 500 in more than 20 years of history, and July marked one of the sharpest hedge fund de-grossing episodes of the past decade," Goldman strategists led by Ben Snider said. "Funds trimmed positions in a number of AI stocks, including many semiconductors and most of the mega-caps," it added.

Hedge funds have begun to diversify from artificial intelligence, even after they entered last quarter "all in on AI" with portfolio turnover at the highest since 2021, according to Goldman Sachs.

"Hedge fund performance, leverage, and the most popular long positions have swung sharply with the AI trade during the last few months," Goldman said.

Hedge funds delivered strong gains in the second quarter as the market was being fueled by popular AI stocks, which helped hedge fund crowding climbed to a record, Goldman said. Last quarter, tech accounted for 14 of the 20 so-called Rising Stars with the largest increases in hedge fund popularity, it noted.

That said, while hedge fund gross leverage, net leverage, and AI exposure have each declined from their Q2 highs, they still rank above longer-term averages, according to Goldman.

"Despite the volatility, US equity long/short hedge funds have returned 10% through mid-August."