- Global hedge funds suffered broad intraday losses due to concerns over AI profitability
- Crowded positioning left hedge funds exposed on both sides
- Higher capital costs should increase dispersion between corporate winners and losers
- Investors should diversify across managers and strategies; favour funds with lower market exposure
Cracks in the hedges. Hedge funds suffered one of their most widespread daily declines since the Covid-19 pandemic on 22 Oct after growing doubts about the financing and profitability of AI-related investment triggered a sharp reversal in technology equities. Fundamental and systematic equity long/short managers fell by 1.4% and 1.3% respectively, while technology-focused managers lost 2.7%. Rising oil prices and renewed inflation concerns added to the pressure. The drawdown was particularly noteworthy because hedge funds had become increasingly sensitive to broader equity market movements, following the AI rally which started in 2023. Many funds had increased their long positions relative to their short positions, raising their net exposure to further market gains. At the same time, managers had crowded into many of the same popular technology companies. This combination of higher net-long positioning and crowding amplified losses when technology shares retreated.
Dispersing the crowd. To better understand the situation, it is useful to consider how equity long/short strategies operate. These managers seek to profit by identifying both winners and losers in the stock market. They buy shares of companies expected to outperform and short-sell those which are expected to underperform. In principle, this allows them to generate returns, even when the broader market struggles. In practice, however, their sensitivity to market movements depends on the balance and overall size of their long and short positions. For example, a fund with USD100 of investor capital might hold USD130 in long positions and USD70 in short positions. Its net market exposure, representing the difference between the two, would therefore be 60%, while its gross exposure would be 200%. The portfolio would consequently be both directionally net long and substantially leveraged. Although the short positions might cushion losses in a falling market, that protection can break down when crowded trades unwind.
This dynamic was evident during the 22 Oct sell-off. As popular technology shares retreated, funds seeking to reduce risk sold overlapping long holdings, adding to the downward pressure on prices. At the same time, rebounds in heavily shorted stocks inflicted further losses on managers betting against them. Funds were therefore squeezed on both sides of their portfolios as crowded long positions fell while crowded short positions rose. With more than two-thirds of hedge funds reporting negative returns, the episode highlighted the risks of pursuing similar trades, even within supposedly diversified portfolios. A successful long/short strategy, therefore, depends not only on selecting the right companies, but also on managing net market exposure, factor overlap, and concentration across both the long and short books.
Structural tailwinds continue to underpin hedge funds. Importantly, the recent declines did not erase the gains achieved earlier in the year with equity long/short strategies remaining c.10.7% higher YTD through 22 Oct. While the sharp reversal illustrated how quickly performance could deteriorate when concentrated positions unwind, it represented a setback, rather than a complete loss of earlier gains. At the industry level, hedge funds continued to attract and grow capital despite more severe market drawdowns of 2025. Global assets under management (AUM) reached a record USD12.6tn in the fourth quarter of 2025 and rose further through the first half of 2026 with much of the 2026 increase driven by investment gains. This performance is consistent with our historical analysis, which shows that hedge funds have often experienced smaller drawdowns than equities during market corrections, supported by their ability to adjust exposures and access sources of return beyond rising stock prices. The October sell-off, therefore, does not invalidate the diversification case for hedge funds. Instead, it reinforces the importance of manager selection and careful scrutiny of concentration risk, particularly exposure to crowded trades.
The case for hedge funds remains. Looking ahead, a higher interest rate environment maintains a favourable backdrop for skilled stock pickers. Elevated financing costs raise capital discernment by elevating the costs of wrong bets, thereby widening the gap between winners and losers. These differences can lead to greater variations in stock performance, creating opportunities for long/short managers to profit. We therefore remain constructive, favouring managers with disciplined risk management and relatively lower net exposure to overall equity market movements. We see particular scope for stock selection across technology and healthcare – fields where deeper expertise is needed to discern investment outcomes, and expertise which is not common to the general investor public – to achieve wider alpha.
Diversification remains key in hedge fund investing. A multi-strategy approach, combining equity long/short strategies with complementary relative-value and discretionary macro reduces reliance on the performance of any single investment approach. A carefully constructed fund of hedge funds (FoHF) portfolio can further diversify sources of correlated risk in crowded trades and ensure sustainable alpha generation in the long run. With market beta doing a lot of the heavy lifting in the equity markets over the last three years, we believe the case for market-neutral strategies and other sources of alpha generation would buttress investor portfolios for potential uncertainties ahead.
Figure 1: Hedge funds have held up on a YTD basis despite AI spook
Source: Aurum, DBS. Data as of 23 Oct 2026
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