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Why hedge funds are betting on technology and AI: Where are the new opportunities in the current market environment?

Overnight, Goldman released what its “Flow” trader Michael Nocerino describes as “two of our traditionally most popular research reports of the quarter” – the Hedge Fund Trend Monitor and Mutual Fundamentals, a monitor of mutual fund trends.

We start with the Hedge Fund Trend Monitor, which analyzes 697 hedge funds with total equity positions worth $3.0 trillion ($1.9 trillion long and $1.1 trillion short) and looks at positions as of the end of the third quarter. of 2024, based on 13-F documents published on November 14, 2024.

Here are the summarized conclusions:

1. RESULTS: Long positions of hedge funds have increased the profitability of American long/short strategies to +14% since the beginning of the year. Goldman’s most popular long portfolio, Hedge Fund VIP (ticker: GSTHHVIP), has returned +30% year-to-date, nearly double that of the similarly valued S&P 500 (16%) and the portfolio with the most concentrated short positions (GSCBMSAL, 16%).

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Hedge fund long positions have outperformed both concentrated short positions and the broader equity market in most sectors since the beginning of the year. Only in the Communication Services and Materials sectors did long positions lag behind concentrated short positions, but these two sectors together account for only 15% of hedge funds’ net exposure.

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2. Leverage and short positions: Hedge funds sharply increased net leverage after the 2024 US presidential election, while reducing gross leverage. This dynamic is consistent with historical periods surrounding presidential elections.

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Although the sample is small, the recent historical trend shows that hedge funds increase net leverage and reduce gross leverage after election day, and then maintain roughly stable exposures in the following months as they analyze the political outlook.

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Short interest at the individual stock level has declined in recent months and remains well below historical averages in most sectors. The average stock in the S&P 500 has short interest equal to just 1.8% of market capitalization, which places it in 19th place compared to historical values. Among sectors, only Consumer Staples and Utilities have short interest at or above their respective 30-year averages.

3. THE GRAND MEGA-CAPS AND THE AI TRADE: Hedge funds made stock changes related to the key themes of the year – the exclusivity of mega-caps and the enthusiasm around AI. Amid the “Gorgeous Week,” hedge funds increased their net positions in NVDA and TSLA . Hedge funds also reduced their positions in AAPL and AMZN. In a broader context, funds shifted their portfolios slightly from large companies to mid-cap stocks in the third quarter.

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As part of the AI ​​trade, funds added nuclear-related stocks (what we called “The Next AI Trade” in April), represented by the GS Uranium & Nuclear (GSXURANI) portfolios, which continued to gain popularity among hedge funds. Portfolio companies, such as VST, entered the Hedge Fund VIP list this quarter. At the industry level, funds reduced their long exposure to semiconductors for the first time since the second quarter of 2022, adding positions in the software sector instead.

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As China’s stock market rose at the end of the third quarter, hedge funds increased their positions in Chinese ADRs. At the start of the fourth quarter, 25% of U.S. hedge funds were long at least one Chinese ADR, the highest share since late 2021. Among ADRs, JD was the stock with the largest net increase in the number of U.S. hedge funds holding it. Also, among ETFs, hedge fund ownership of KWEB and FXI increased last quarter. Of course, as always, China’s stimulus euphoria proved short-lived, and most Chinese positions have since collapsed.


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4. VIP HEDGE FUNDS: Mega-caps AMZN, META, MSFT, GOOGL, NVDA and AAPL remained at the top of the list of most popular positions among hedge funds. The Hedge Fund VIP portfolio has outperformed the S&P 500 since the beginning of the year (+30% vs. +25%) and has outperformed the S&P 500 in 60% of quarters since 2001 (although when it has lagged, the declines have been significant). The portfolio has strong historical returns but with high volatility.

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The VIP list contains 50 stocks that appear most frequently among the top 10 of the major hedge funds. The Hedge Fund VIP portfolio is not sector neutral to the S&P 500. The VIP list includes stocks from 10 of the 11 sectors, with the Real Estate sector being absent. “Information technology” (24%) represents the largest share of the portfolio.

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5. SECTORS: Healthcare remains the sector with the highest hedge fund volume, while Information Technology is the most undervalued relative to the Russell 3000.

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However, over the past quarter, funds have gradually reduced their exposure to healthcare and shifted to TMT (technology, media and telecommunications). (And that was a good move given the catastrophic decline in healthcare stocks in recent days.) The shift out of healthcare was widespread, while the shift into TMT was concentrated in Software.

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Hedge funds reduced their exposure to 9 of the 10 healthcare subsectors, with the largest declines in Managed Healthcare, Pharmaceuticals and Biotechnology. The increase in exposure to Information Technology was concentrated in Applications Software and Systems Software. ANSS, APP and SMAR are three software companies that entered the hedge fund VIP positions list this quarter.

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The tables below show the stocks in the Consumer Staples and Financials sectors that saw the largest net increases in popularity among hedge funds over the past quarter. The table compares the number of funds that have created new positions or increased existing ones, versus the number of funds that have reduced or completely closed their positions.

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Turning to mutual funds, Goldman’s Mutual Fundamentals report analyzes the end-of-quarter positions of 558 large-cap mutual funds that manage a total of $3.9 trillion in equity assets.

Highlights


1. RESULTS: Only 31% of large-cap mutual funds have outperformed their benchmarks year-to-date. Mutual funds typically reduce their cash positions after Election Day, but cash on hand is now at a record low. Both mutual funds and ETFs saw net inflows after Election Day, similar to the situation in 2016.

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2. TOPICS OF FOCUS:

  1. Mega-Cap Technology: The average large-cap mutual fund has 806 basis points of volume since the “Great Week” (compared to 671 bps in the second quarter). Four of the “Great Week” stocks are among the 20 stocks with the largest position reductions (MSFT, GOOGL, META, NVDA), while TSLA is the stock with the largest position increase.
  2. Index Weighting Changes: S&P and Russell announced the introduction of volume limits in certain indices. Underweight positions in large-cap stocks have been a major factor in the funds’ poor performance since the beginning of the year. The top four funds had a neutral volume of (30%) in the “Magnificent Week,” while the bottom four funds had only 11% of their assets in these stocks. The cap means that if the largest stocks continue to outperform, the funds will not automatically become underweight in these stocks.
  3. US Elections: The tilt in mutual fund positions ahead of Election Day suggests that they benefited from a number of policy-related changes. Mutual funds have large overweight positions in “Financials”, “Cyclical Goods” and stocks with high sales in the US, which have performed well after the election results.
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3. SECTORS: The average mutual fund remains the largest in the “Financials” (+187 bps) and “Industrials” (+162 bps). The smallest volume remains in the “Information Technology” sector (-483 bps), with exposure to the sector reduced the most since the second quarter of 2020 and at its lowest level in the last 10 years. This is likely due to the sector’s strong performance and diversification constraints.

Across all management styles – “fundamental”, “growth” and “value” – funds added exposure to “Materials” and “Consumer Goods” but reduced exposure to “Consumer Goods” and “Information Technology”

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4. STOCKS: The performance of the largest volumes in stocks in mutual funds (GSTHMFOW) has outpaced the even distribution in the S&P 500 since the beginning of the year (+22% vs. +17%), but lags behind the smallest volume stocks (GSTHMFUW, +23%).

We are updating the portfolios in this report:

  • 11 new companies in GSTHMFOW: VRT, LOW, BDX, BMY, LH, STT, APD, SPOT, CB, KDP, GPN.
  • 4 new companies in GSTHMFUW: PLTR, ACN , ADP, ED.
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5. HISTORY SHOWS: Mutual funds reduce their fiat positions after election day. In nine presidential election years since 1988, fiat funds as a share of assets have declined by an average of 0.3 percentage points in the months after the elections. Similar dynamics were observed after the 2016 elections.

However, Mutual fund fiat balances are now at record lows. U.S. mutual fund holdings of fiat as a percentage of total assets are just 1.4%, a record low.

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