Following the July selloff in AI-related equities that rattled Wall Street, systematic hedge funds suffered their worst single-day performance in over two years on Wednesday.
A Goldman Sachs internal memo, reported on August 20th, revealed that as of 1 PM ET, its systematic long/short equity basket was down 1.4%, marking the worst daily drop in more than two years. The deviation of the bank's "Global Momentum" index has moved significantly beyond its normal historical range. The market turbulence was triggered by the US Treasury's announcement of plans to "at least double" purchases of long-dated bonds to stabilize the market, and a near-tripling of vaccine maker Moderna's share price following positive trial results for an experimental skin cancer therapy.
This latest shock has compounded the struggles of momentum-based trading strategies, which have been under pressure since the AI stock rout began weeks ago. It has also reignited concerns about the ability of quant funds to operate effectively in a highly volatile environment.
Momentum strategies hit by unusual shock
The losses were concentrated in funds with significant exposure to the momentum factor—strategies that systematically buy rising stocks and sell falling ones.
According to a Morgan Stanley client memo, this marked the first time in at least five years that its "pure momentum" index fell more than 4% in a single day, even as the S&P 500 closed higher. A portfolio manager at a large asset manager noted that it doesn't take many individual stock moves like Moderna's to make risk managers nervous, highlighting how a single stock's violent swing can create a chain reaction across the entire quant strategy system.
One hedge fund manager described the situation bluntly, stating that volatility is extremely unusual and options market makers are suffering on all sides. The market rotates daily, with today's winners almost certainly becoming tomorrow's losers.
A senior executive at a top quantitative hedge fund used an earthquake analogy to explain the current market dynamics, suggesting that after a magnitude 7 earthquake, aftershocks are inevitable. The market won't go to zero, but participants are reducing their risk exposure. This illustrates the core dilemma facing quant funds: in extreme volatility, synchronized deleveraging and risk reduction actually amplify the market's non-linear moves, creating a self-reinforcing negative feedback loop.
Quant funds have faced similar challenges before. In 2018, the industry entered a prolonged "quant winter" that lasted several years, with automated investment strategies broadly underperforming and profitability suffering.
Despite the recent turmoil, the Goldman memo indicated that systematic long/short funds are still up roughly 1.7% for the month so far, suggesting the situation hasn't yet become a full-blown collapse.
It's worth noting that in July, a multi-week selloff in AI-related stocks caught Wall Street off guard, with numerous hedge funds posting monthly losses. The most prominent example was the highly leveraged AI-focused fund Situational Awareness, which was ultimately forced to sell most of its public market stock positions to Citadel at a significant discount.
Even institutions known for consistent profitability were not immune. Reports indicate that Jane Street, the secretive trading firm that dominates global markets, recorded losses of approximately $15 billion last month due to its bets on Situational Awareness and related AI stocks.