According to data from Morgan Stanley, hedge funds have reduced their exposure to the broader AI trade to an "Underweight" position for the first time since early 2023, bringing an end to the longest sustained portfolio de-risking period in more than 15 years.
Data from Morgan Stanley's prime brokerage business as of Thursday showed that cumulative gross flows from hedge funds have dropped 8% from their June peak, marking the largest sustained deleveraging on record, as managers failed to rebuild exposure across several rounds of drawdowns between summer and October.
Tech stocks bore the brunt of the selling as investors grew increasingly concerned that massive investments in AI infrastructure are not generating returns quickly enough. Last week's quarterly earnings reports from Alphabet (GOOGL.US) and Amazon (AMZN.US) unsettled Wall Street.
While short covering helped push U.S. long-short net leverage up 5 percentage points to 51%, gross leverage slid to 207%, indicating that managers are shrinking their overall book size rather than deploying new capital.
Data from Goldman Sachs' prime brokerage business confirmed that recent equity buying was almost entirely driven by closing out bearish positions rather than establishing new long positions.
During the period from October 23 to October 29, funds recorded net buying of U.S. equities for the first time in four years. Index and ETF products accounted for 73% of total buying, with short positions in U.S.-listed ETFs declining 4.8%, the largest short-covering wave in more than six months.
Although the information technology sector topped sector net inflows, the buying only recovered 40% of the sector's selling volume over the prior three weeks. The "Magnificent Seven" large-cap tech stocks were net sold on four out of five trading days.
Goldman Sachs data showed that even as fundamental long-short net leverage rebounded 3.6 percentage points to 47.0%, it remained near multi-year lows at around the 5th percentile of the five-year range. The long-short ratio was locked at 1.555, in the 1st percentile.
After pre-weekend selling brought gross flows into balance, the prime brokerage desk noted that suppressed net exposure leaves significant room for further short covering, which could potentially drive the market toward an eventual turning point.
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