Retail Pours Billions Into ETFs As Hedge Funds Go Underweight AI

Stock-picking hedge funds unwound positions in October faster than in any month in more than a decade.

According to The Wall Street Journal, Morgan Stanley noted hedge funds reduced market exposure by about 9% since June, while more than 40% were flat or down for the year through October, despite the S&P 500 and Nasdaq still being up.

Over the same period, money kept flowing into the cheapest index funds. Based on ETF.com data, the Vanguard S&P 500 ETF (NYSE:VOO), Invesco QQQ Trust (NASDAQ:QQQ) and iShares Core S&P 500 ETF (NYSE:IVV) took in about $31 billion in net inflows from the start of October through Nov. 10.

Underweight AI

The hedge fund pullback was painful. Lone Pine Capital was up more than 40% in the first half. After an 8.8% loss in October, it was down 7.5% for the year before fees. Samlyn Capital is narrowing its focus to financial stocks. Engineers Gate is closing most of its “quantamental” business, and Walleye Capital let go of several portfolio managers.

According to Goldman Sachs, hedge funds focused on tech, media and telecom lost more than 4% on Nov. 5 alone. That decline erased the last of the gains for funds that were up as much as 24% year-to-date before the summer doldrums arrived.

Morgan Stanley’s prime brokerage desk also said hedge funds have turned underweight the AI trade for the first time since early 2023. It called this the longest stretch of de-risking in more than 15 years.

Ignoring the Smoke Alarm

Retail investors moved the other way. In the week ended Oct. 23, ETFs pulled in $44.1 billion, led by $6.2 billion into VOO and $2.7 billion into QQQ. At that point, the Nasdaq-100 was down about 7% from its peak, which is not yet a correction. Two weeks later, it was down almost 15%, before staging a 6% rally this week.

Nov. 5 was the worst day for the Nasdaq-100 since 2020, and the S&P 500 fell 1.4%. QQQ dropped 6.5% that day but still took in $2.8 billion, its largest single-day inflow since Oct. 30. Interestingly, Fidelity’s brokerage data showed small investors also buying the 3x-leveraged Direxion Daily Semiconductor Bull 3X ETF (NYSE:SOXL).

Bloomberg’s Eric Balchunas counted roughly $12 billion a day flowing into ETFs over five days, with the top 17 ETFs all equity funds.

“I am concerned that we now have a generation of investors who run into the building when the smoke alarm goes off,” Interactive Brokers strategist Steve Sosnick said.

Retail in Lead 

Not every ETF dollar comes from retail. Goldman’s prime brokerage data showed that when hedge funds briefly turned net buyers in late October, 73% of their buying went into indexes and ETFs. TD Wealth also warned that some October inflows reflect tax-loss harvesting, not fresh money.

Light hedge fund positioning can also work both ways. Morgan Stanley’s prime desk said depressed net exposure leaves room for more short covering if the market turns. Hedge funds selling to retail could set up a sharp rebound, or it could leave retail holding the bag.

As of today, the sharp pullback in both the Nasdaq and the S&P 500 suggests that, at least for now, retail dip-buyers made the right call.

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