Hedge funds face risk of further rotation despite strong returns – Goldman’s Ben Snider

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CHOLTICHA KRANJUMNONG

Hedge funds are facing a heightened risk of further rotations ahead despite delivering a year-to-date return of +8%, according to Goldman Sachs.

Short interest for the median S&P 500 (SP500 [https://seekingalpha.com/symbol/SP500]) stock represents 2.3% of float – down from 2.4% in June – but still near the highest level since 2019, while Goldman’s Hedge Fund Crowding Index remains near record highs.

[Concentrated shorts have squeezed higher in recent months]
Concentrated shorts have squeezed higher in recent months (Goldman Sachs Global Investment Research, Goldman Sachs FICC and Equities)

“Market breadth registers one of the narrowest levels in recent decades, a dynamic that has often preceded short squeezes in the past,” said Ben Snider, Goldman Sachs senior equity strategist.

Also, position turnover among hedge funds last quarter jumped to the highest level since 2021. Hedge fund crowding appears to have hampered alpha generation during the 2Q 2025 earnings season, with data showing an increasingly negative relationship between hedge fund popularity and the magnitude of a stock’s excess return after reporting quarterly results, Snider said.

According to the research, the strength of long portfolios has supported hedge fund returns despite a 30% squeeze in the most crowded short positions during the last three months.

Equity hedge fund gross leverage remains elevated vs. history despite the recent short squeeze, Snider added.

GS Prime Services data shows that fundamental long/short equity hedge fund gross leverage ranks in the 95th percentile compared to the last five years, while net leverage sits in the 52nd percentile.

Snider also pointed out to significant shifts in sector allocations. Hedge fund sector tilts relative to the Russell 3000 (IWV [https://seekingalpha.com/symbol/IWV]) increased most in health care (XLV [https://seekingalpha.com/symbol/XLV]) and decreased most in information technology (XLK [https://seekingalpha.com/symbol/XLK]), with funds rotating toward health care in the second quarter despite a -7% return for the sector during the quarter.

[The most popular hedge fund long positions have outperformed in most sectors YTD]
The most popular hedge fund long positions have outperformed in most sectors YTD (Goldman Sachs Global Investment Research)

Also, hedge funds entered the third quarter with “a record underweight in communication services (XLC [https://seekingalpha.com/symbol/XLC]) and the largest underweight in information technology on record outside 2024,” he said.

The narrow market breadth in U.S. equities may signal trouble ahead, Snider concluded. Although the S&P 500 (SP500 [https://seekingalpha.com/symbol/SP500]) trades near a record high, its median constituent remains 11% below its 52-week high – representing the narrowest market environment since late 2023.

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