Goldman Sachs strategists, led by Ben Snider, note in a recent report that hedge funds and mutual funds are continuing a significant sector rotation—dramatically reducing exposure to software stocks while further increasing investments in semiconductors. This shift highlights investors repositioning for the next phase of the AI-driven equity market rally.
The latest Goldman Sachs "U.S. Weekly Kickstart" report analyzed approximately $9 trillion in equity holdings across hedge funds and large-cap mutual funds. It found that hedge fund portfolio exposure to semiconductors has surged to a record high, while their allocation to software stocks has dropped to its lowest level since 2019. Concurrently, mutual funds, excluding Microsoft, have reached their largest underweight position in software since 2012.
This rotation reflects a broader reassessment within tech investing, as money managers increasingly favor companies building AI infrastructure over many firms selling enterprise software tools. Within semiconductors, hedge funds increased positions in Lam Research, Applied Materials, and ASML in the second quarter, while mutual funds raised exposure to Intel and SiTime. Both groups were net sellers of Microsoft in Q2.
The report also indicates a widening divergence between active fund managers and the broader market rally. According to Goldman Sachs Prime Services data, hedge funds have achieved a 7% return year-to-date, aided by a rebound in momentum stocks during Q2. Large-cap mutual funds also averaged a 7% gain, but only 30% have outperformed their respective benchmarks this year, below the historical average of 37%.
Why these positioning data matter is they provide a window into where institutional investors believe the next market leaders may emerge. The rotation into semiconductors suggests professional investors remain committed to the AI build-out but are becoming more selective about which parts of the tech ecosystem can sustain earnings growth and justify elevated valuations.
The report also underscores the growing concentration risk in a market dominated by a handful of mega-cap tech companies. Goldman Sachs points out that the ten largest companies now account for 40% of the S&P 500's total market capitalization and 36% of its total earnings.
Despite earlier geopolitical tensions this year, hedge funds have been actively rebuilding risk exposure. Goldman Sachs states that hedge fund net leverage has climbed back to the 85th percentile compared to the past five years, while gross leverage remains elevated versus historical norms. Meanwhile, mutual funds have modestly increased cash levels from historic lows, though allocations remain low by historical standards.
Sector positioning shows broad consensus between hedge funds and mutual funds across many market areas. Both groups are generally overweight the Industrial sector and underweight Information Technology, but hold sharp disagreements on Financials and Consumer Discretionary stocks. Hedge funds are overweight Consumer Discretionary, while mutual funds are underweight. The opposite is true for Financials.
Goldman Sachs also identified four "shared favorite" stocks held significantly by both hedge funds and mutual funds: Boeing, Mastercard, Marvell Technology, and Visa. These stocks have delivered a 10% return year-to-date, outperforming the equal-weight S&P 500 index by approximately three percentage points.
Despite the strong equity rally, strategists maintain a relatively cautious stance on the broader market. Goldman Sachs' year-end 2026 target for the S&P 500 is 7600, implying roughly 2% upside from current levels around 7446. Meanwhile, valuations remain stretched by historical standards. The S&P 500 currently trades at a forward P/E of about 21x, while the Nasdaq 100's forward P/E is near 26x. Among sectors, Industrials and Consumer Staples trade at the richest premiums relative to their own historical ranges.
However, Goldman Sachs strategists believe earnings growth remains supportive, forecasting S&P 500 EPS of $309 for 2026 and $342 for 2027.
Comments