Hedge funds hit record July setback as AI trade unravels

Goldman Sachs data showed hedge funds suffered their weakest month versus the S&P 500 in over 20 years in July, driven by a reversal in stocks tied to artificial intelligence that led managers to cut positions and reduce leverage.

The bank’s analysis found a basket of the stocks most widely held by hedge funds posted its worst one-month performance relative to the S&P 500 in more than two decades of data. The unwind produced one of the most pronounced episodes of de-grossing in the past ten years, with reductions concentrated in semiconductor firms and several large-cap technology companies.

Hedge funds entered the second quarter heavily positioned for further AI gains. Portfolio turnover rose to its highest level since 2021 as managers increased allocations to companies viewed as AI beneficiaries. Those positions helped drive strong returns in the second quarter and led to record levels of crowding in several names.

Goldman identified 20 “Rising Stars” — companies that saw the largest increases in hedge fund ownership during the quarter — and found 14 were technology stocks. That concentration increased vulnerability when AI-related prices reversed in July.

During the sell-off, managers reduced both gross and net leverage and pared overall AI exposure from the peaks reached in the second quarter. Despite the pullback, leverage levels and AI weightings remained above their longer-term averages.

Trimming affected a range of firms tied to the AI investment case, including chipmakers supplying data-center demand and several mega-cap tech companies whose valuations had risen on AI expectations. Managers reduced concentrations in the most crowded names and adjusted exposure across portfolios.

US equity long-short hedge funds remained profitable for the year despite July’s setback. Goldman estimated the strategy had returned roughly 10% through mid-August, indicating gains from earlier quarters offset part of the recent underperformance.

Goldman Sachs’ data showed hedge fund returns had become closely linked to the AI theme and that positioning unwound rapidly when market sentiment shifted in July.