Hedge funds suffered significant losses in July as the artificial intelligence rally lost momentum, according to Goldman Sachs. The bank said the pullback in AI-related stocks forced managers to unwind some of their heaviest positions, producing one of the strongest de-grossing periods of the past 10 years.

"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," the bank noted in a research note (CNBC on X). Goldman added that hedge funds are currently pulling back quickly from AI stocks.

Hedge funds lost over 3% of their profits in July

Goldman asserted that hedge fund performance, leverage, and key long positions have shifted considerably as the AI trade changed course, and data from across Wall Street supports this cooling-off period.

In early August, JPMorgan argued that tech sell-offs wiped out 3% of hedge fund gains in July (Reuters). According to the bank's analysts, fund managers were trapped in overcrowded tech positions, creating a bottleneck that prevented speculators from cashing out before their profits vanished.

However, the summer slump may form part of a predictable seasonal pattern. JPMorgan noted that since 2018, hedge funds have tended to dump unprofitable stock positions in July. On the basis of this cycle, the bank suggested that traders could well pick up tech stocks again by September, noting that managers frequently drop trades in mid-summer only to buy back into the market in the coming months.

When the AI trade began losing momentum this year, analysts were still optimistic about the theme and about hedge fund performance. In late July, Vincent Lin, co-head of Prime Insights and Analytics in Global Banking & Markets, noted that hedge funds were still deeply committed to AI technology. At the time, he explained that the historic wave of tech selling looked more like a healthy market correction amid high volatility than a decline in confidence in AI. With traders currently moving away from AI, it is unclear whether investors remain bullish on tech stocks.

Earlier this year, the war in Iran triggered a rough March for hedge funds, although the funds rebounded quickly thanks to a massive chip stock rally led by Samsung, AMD, and SK Hynix.

AI boom drove unusually strong Q2 performance

The AI stock frenzy was the primary driver of second-quarter hedge fund performance, propelling investor crowding to historic heights. Per Goldman, tech stocks grabbed 14 out of 20 spots among the fastest-growing favorites on Wall Street.

Overall, according to data provider HFR, strong investment performance helped boost total industry assets by $409 billion, bringing the grand total to $5.6 trillion in the quarter. The data also showed that macro strategies, in which hedge funds make investment bets tied to indicators such as growth and inflation, took the crown as the most sought-after hedge fund style this year.

Speaking on that strong performance, Shenan Dhanani, co-chief executive at Trium Capital, noted that this could be a "golden era" for the funds. Hedge fund performance has since slipped from those highs, though the funds are still outpacing their usual averages.

The concentration of hedge fund portfolios in AI-linked companies also made the July reversal more painful. Stocks connected to semiconductors, cloud computing, and AI infrastructure had attracted significant institutional demand during the rally, leaving many managers exposed to the same group of trades. When momentum weakened, crowded positioning amplified losses as investors rushed to reduce their exposure simultaneously. For markets, the episode underscores how quickly performance can shift when a small cluster of favored technology names drives a large share of returns. It also leaves hedge fund positioning in focus into the next earnings and macro data releases, since those signals can influence whether managers keep trimming exposure or rebuild it.

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

If hedge funds return to technology stocks in September, the latest pullback could prove to be little more than a summer repositioning. Continued weakness in AI-related shares, however, could force managers to reassess the positions that helped drive their strong gains earlier this year.