U.S. hedge funds have dramatically raised their equity exposures in the past month, showcasing confidence in taking on idiosyncratic risks despite growing macro uncertainties. As noted by Goldman Sachs’ prime brokerage team, this marks the fourth consecutive week of net buying, with last week recording the largest dollar amount in buys since November.

Why Are Hedge Funds Buying?

According to Vincent Lin from Goldman Sachs, the sustained long buying reflects hedge funds’ increasing confidence in their ability to pick stocks. Amid volatile interest rate expectations and geopolitical troubles, managers are prioritizing individual names over macro investments, seeking alpha from unique opportunities.

Sector Trends: Technology Leads the Charge

Information Technology Accounts for Heavy Long Purchases

Across 11 U.S. sectors, 10 registered net long inflows, with information technology leading the way. This sector saw the largest net buying in over a decade, primarily driven by strong demand for semiconductor and semiconductor equipment stocks. Meanwhile, some software stocks experienced minor sell-offs.

• Semiconductor Demand: Chipmakers and their suppliers attracted most of the inflows, as investors expected sustained demand for data center and AI hardware.

• Software Sector Adjustments: Some high-multiple SaaS companies were trimmed, allowing funds to move towards more cyclical segments.

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Market Rotation: From Megacaps to China ADRs

Cutting Back on Major U.S. Stocks

Last week, hedge funds decreased their holdings in the so-called Magnificent 7 stocks that have driven recent market gains. Nevertheless, these stocks have yielded returns of +12% in Q2 so far, demonstrating their ongoing strength amid diversification efforts by fund managers.

Increasing Exposure to Chinese ADRs

At the same time, hedge funds have added to First Quarter positions in Chinese American Depository Receipts (ADRs), led by:

• Alibaba Group (NYSE:BABA)

• PDD Holdings (NASDAQ:PDD)

• Baidu (NASDAQ:BIDU)

• JD.com (NASDAQ:JD)

Despite escalating U.S.-China trade tensions at the end of the quarter, hedge funds were hopeful for these ADRs to outperform, but they have lagged behind U.S. counterparts.

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Evaluating Performance and Thematic Positioning

• Magnificent 7 Outperforms: Despite reduced exposure, these large-cap stocks maintain their strong Q2 performance, reiterating their defensive characteristics and market dominance.

• Underperformance of Chinese ADRs: Trade concerns and diminished risk appetite have made these ADRs underperform against U.S. stocks.

Hedge funds remain substantially invested in major U.S. megacaps, reflecting confidence that these blue-chip stocks will continue to generate solid returns if growth expectations stabilize.

Risk Management: Leverage and Short Interest Dynamics

Ben Snider from Goldman emphasizes that despite a turbulent macro environment, U.S. equity long/short hedge funds have recorded a 1% YTD return, substantially aided by disciplined stock selection. However, a rising short interest in the marketplace has pushed hedge funds’ gross leverage to historic highs, intensifying performance pressure.

• Increased Leverage: As more fund managers enhance their short positions to hedge equity risks, long positions must significantly outperform to offset borrowing costs.

• Monitoring Short Interest: High levels of short positions in certain sectors may indicate potential squeeze scenarios if market sentiment changes.

Implications for Investors

1. Identifying Opportunities: Hedge funds’ focus on specific stock catalysts prompts retail and institutional investors to look for high-conviction names in semiconductors, specialized software, or select Chinese ADRs that might benefit from eased U.S.-China tensions.

2. Megacap Stability: The Magnificent 7 persists as popular investments due to their strong financials and growth potential, reminding investors that trimming large-cap positions should be tactical rather than fundamental.

3. Leverage Considerations: Elevated gross leverage indicates greater market volatility ahead. Keeping an eye on short interest and liquidity can provide insights regarding potential market reversals.

By actively monitoring sector flows and stock movements using tools like Market – Biggest Gainers and Market – Most Active APIs, investors can remain informed about the hedge fund landscape, locate emerging trends, and proactively manage risks as market dynamics shift.