Goldman Sachs hedge fund tracking: Technology giants remain the most crowded trades, but smart money is starting to seek new alternatives.

At a time when the market value of the "Tech Seven Giants" in the US stock market continues to "inflate," hedge funds are concerned that tech stocks may not replicate last year's gains and are beginning to seek new directions.

On February 20th, Goldman Sachs strategists Ben Snider and Jenny Ma pointed out in a report that starting from the fourth quarter of 2023, hedge funds began to reduce their exposure to the "Seven Sisters" of US stocks and seek opportunities in cyclical industries, betting on the recovery of global manufacturing.

Goldman Sachs' analysis of 722 funds with a total stock position of $26 trillion showed that in the first three quarters of 2023, hedge funds heavily bought into the "Seven Giants" (Alphabet-C, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla), with the "Seven Sisters" accounting for 13% of the long positions in hedge fund portfolios. Except for Tesla, the other six companies all ranked among the "Top 10 Most Popular Stocks Among Hedge Funds."

Goldman Sachs described the characteristics of hedge funds in the fourth quarter of 2023 as highly concentrated, crowded trading, and seeking new directions: 1. 70% of the funds in hedge funds' long portfolios were concentrated in the top 10 positions, 2. The hedge fund crowding index hit a historical high, 3. Starting from the fourth quarter, hedge funds began to reduce their positions in super popular large-cap stocks while seeking alternatives.

Although the above seven companies maintained strong performance in 2024, with an average total return of up to 8%, far exceeding the S&P 500 index's 5%, the market's attitude towards them has shifted.

Goldman Sachs' hedge fund VIP list shows that Microsoft has unfortunately fallen into the ranks of the "fallen stars," becoming the stock with the largest decline in popularity among hedge funds. Amazon, on the other hand, has shown relatively strong performance in this wave of selling off, with its ranking even rising to the top of the hedge fund VIP list.

Goldman Sachs pointed out that hedge funds are seeking opportunities in cyclical industries, betting on the recovery of global manufacturing. Companies such as General Electric and Union Pacific have successfully made it onto Goldman Sachs' hedge fund VIP list.

The change in hedge funds' attitudes has raised concerns in the market about the future trend of tech stocks. Goldman Sachs warned in the report that behind the high returns brought by the "Seven Sisters" lies high crowding and record momentum tendencies, which means that once the market environment changes, there may be a risk of sharp pullbacks. Investors facing this situation need to formulate investment strategies more cautiously.

The weight of the "Seven Sisters" in hedge fund portfolios continues to rise

Goldman Sachs pointed out that the rising stock prices of the "Seven Sisters" have led to a continuous increase in their weight in hedge fund portfolios, resulting in record momentum skewness and extreme crowding. These stocks account for 13% of long positions in hedge fund portfolios, reaching a historical high. However, this proportion is only half of their collective weight in the Russell 3000 index: In 2024, hedge fund returns surged significantly under the impetus of the seven tech giants, with the most popular hedge funds generating strong alpha returns at the beginning of the year. Our hedge fund VIP basket, which includes the most popular long positions of hedge funds, achieved a return rate of 39% in 2023 and 9% year-to-date in 2024.

In contrast, the equally weighted S&P 500 index has only returned 1% year-to-date.

Goldman Sachs pointed out that the performance of the hedge fund VIP basket is evidently in line with the performance of the "seven giants" and other large-cap tech stocks, with popular long positions of hedge funds outperforming the average level. This has also led to a slight increase in concentration within hedge fund investment portfolios and crowding among different portfolios:

Apart from Tesla, the "seven sisters" and Lilly are the most popular long positions in our hedge fund VIP list.

However, in the fourth quarter, hedge funds reduced their holdings of stocks. Goldman Sachs noted that among the tech stocks that saw the most decline in popularity among hedge funds, Microsoft, Apple, and NVIDIA were at the forefront, but Amazon showed relative resilience in this wave of selling, even rising to the top of the hedge fund VIP list.

Shift towards Cyclical Stocks by Hedge Funds?

Goldman Sachs pointed out in the report that against the backdrop of strong U.S. economic data and signs of global manufacturing improvement, hedge funds continue to shift their funds towards cyclical stocks rather than defensive stocks, raising this preference to the highest level since 2016:

While reducing holdings in large-cap tech stocks, hedge funds are also seeking opportunities in cyclical stocks and some growth stocks. Currently, the industrial sector accounts for 18% of the VIP stock basket, second only to financials (20%) and information technology (22%).

Funds have selectively rotated within the "growth" sector while continuing to shift towards cyclical sectors. Overweight positions in the communication services sector have reached their highest level since 2017, reducing exposure to information technology.

In the process of positioning towards cyclical industries, hedge funds increased investments in the financial sector in the fourth quarter while reducing exposure to the industrial sector.

Rising Leverage Ratio and High Risk Exposure for Hedge Funds

Goldman Sachs analysts added that in the past year, the concentrated investments, momentum exposure, and total leverage ratio of hedge funds have helped boost returns. However, these factors also imply the risk of sharp liquidation if market conditions change, as briefly occurred in the final weeks of 2023:

At the beginning of 2024, the momentum tilt of hedge fund portfolios reached a new high (hedge funds prefer stocks or assets that have performed well recently in their investment strategies), and this investment strategy also led to decent returns for hedge funds in 2023. The strong factor performance combined with lower portfolio turnover rates resulted in a historically high tilt of these factors. Goldman Sachs pointed out that the record-breaking "momentum tilt" has led hedge funds' long investment portfolios to tilt towards growth stocks at the highest level since 2016.

It is worth noting that when momentum strategies perform well, hedge funds collectively tend to choose such strategies, leading to an increase in the phenomenon of crowded funds:

"When momentum performs well, hedge fund inflows typically increase, and the significant increase in correlation between factors reaches levels seen only a few times in the past 30 years. This high factor correlation feature appeared during the economic recessions of 2008 and 2020, as well as in 1997, 2011, and 2019."