An exclusive club: Do investors still need hedge funds?

The AI bet backfires

July became one of the worst months for hedge funds in decades. According to Goldman Sachs, the most popular hedge fund positions posted their worst performance relative to the S&P 500 in more than 20 years of tracking.

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The main reason was a reversal in AI-related stocks. Hedge funds had been actively increasing their exposure to the technology sector in the second quarter, while portfolio turnover reached its highest level since 2021. Goldman noted that semiconductor stocks and mega-cap technology companies were particularly popular. In July, funds began cutting these positions aggressively.

Specialized technology strategies were hit hardest. According to Hedge Fund Research, technology-focused hedge funds lost around 7% in July, their worst monthly performance since January 2008. For comparison, the Nasdaq 100 fell by more than 5% over the same period, while hedge funds overall lost an average of 1.1%.

Some managers suffered much larger losses. Altimeter Capital Management lost around 11% during the month, while Marshall Wace’s Eureka fund fell 6.9%. The most striking example was Situational Awareness, an AI-focused fund run by 24-year-old Leopold Aschenbrenner. Its value plunged by around 67%, forcing the manager to sell most of the portfolio to Citadel under pressure from lenders.

Why investors keep putting money into hedge funds

The July setback looks particularly striking against the previous quarter’s results. According to Hedge Fund Research, assets under management in the hedge fund industry increased by $409.3 billion between April and June, the largest quarterly gain on record. By the end of June, the industry was managing a record $5.6 trillion.

Those figures partly reflect the type of investors hedge funds attract. Their clients are primarily wealthy individuals, family offices, pension funds and other large institutional investors. They are willing to hand money to managers who can do more than simply buy stocks and bonds: hedge funds can short markets, use leverage and derivatives, and trade currencies and commodities. For most retail investors, this format remains out of reach, with minimum investments often running into hundreds of thousands of dollars.

In the second quarter, that freedom to use different strategies generated substantial gains. Of the total increase in assets, $364 billion came from investment performance, while another $45.2 billion came from new client money. Net inflows over the past three quarters reached $134 billion, the highest level for such a period since 2007.

One of the biggest sources of profit was the same AI boom that later hurt funds in July. The HFRI Equity Hedge Fund Technology Index gained 19% in the first half of the year. Other strategies also performed well: event-driven funds gained 7.4%, while distressed debt strategies rose 12.4%.

Additional money flowed into hedge funds as capital moved away from private equity and private credit. In those investments, money can remain locked up for five to seven years, while many hedge funds allow investors to redeem their capital within a few months.

Large investors are also attracted by the diversification hedge funds can provide. Managers can allocate capital across different markets and seek profits not only when assets rise, but also when they fall or when price discrepancies emerge.

What is available without $1 million in the bank

For most private investors, hedge funds remain a closed market, but that does not mean it is impossible to build a diversified portfolio without them. The most direct option is to buy stocks and bonds independently. Stocks offer the potential to profit from business growth and dividends, while government and corporate bonds can provide more predictable income.

For those who do not want to pick individual companies, index ETFs are widely available. A single fund can hold hundreds of stocks and track, for example, the S&P 500 or the broader market. The entry threshold is usually limited to the price of a single share, and the investment can be sold during the trading day. Index fund fees are also typically much lower than hedge fund management costs.

The defensive part of a portfolio can be built with other instruments. Investors use gold, short-term government bonds, money market funds and bank deposits. REITs provide another way to gain exposure to real estate, allowing investors to receive a share of income generated by offices, warehouses, shopping centers or residential properties without buying property directly.

Reality without the Hollywood glamour

Many people have watched the TV series Billions, which romanticized the hedge fund world: enormous fortunes, complex trades and managers who always seem to stay one step ahead of the market. Reality is much harsher. July showed that even funds with access to top analysts, expensive data and sophisticated strategies can become too heavily committed to a single idea and suffer serious losses.

That does not make hedge funds useless. For large pools of capital, they remain a way to access strategies that are difficult to replicate independently. But most private investors simply do not need that level of complexity. Stocks, bonds, ETFs, gold and other accessible instruments make it possible to build a diversified portfolio without joining an expensive “club for the elite.”

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