Hedge Funds Reel from Worst Month vs. S&P 500 in Over Two Decades

Goldman Sachs strategists reported that hedge funds suffered their worst monthly underperformance against the S&P 500 in over two decades in July. The AI trade, which had driven market momentum in the second quarter, rapidly lost steam, leaving fund managers facing a 'historic predicament'.

Hedge funds had heavily invested in AI-related holdings, with portfolio turnover reaching its highest level since 2021 and market crowding climbing to record highs in the second quarter. However, as AI momentum faded in July, hedge funds began to deleverage and rotate capital into other sectors.

Goldman notes that while gross leverage, net leverage, and AI exposure have pulled back from their Q2 peaks, they remain above long-term averages. This suggests that fund managers are still taking on relatively elevated risk exposure.

The research firm views July's deleveraging as a sign of the end of the 'all-in AI' positioning unwind, with capital rebalancing toward healthcare, financials, and energy sectors. US long/short equity hedge funds have delivered solid performance year-to-date, returning 10% through mid-August.