Why Situational Awareness hedge fund imploded, even in a tame stock market

The stock market looked unusually tranquil. Beneath the surface, one of Wall Street’s fastest-growing funds devoted to artificial intelligence investments was unraveling.

In a matter of weeks, Leopold Aschenbrenner’s Situational Awareness went from managing roughly $45 billion to being forced into a sweeping reduction of its listed-stock positions as a historic momentum reversal triggered losses on both sides of its portfolio and set off margin calls and compulsory sales.

Situational Awareness had built concentrated positions in one of Wall Street’s most popular trades: owning companies expected to supply the chips, data centers, power and other infrastructure behind the AI boom while betting against software firms viewed as vulnerable to the technology’s disruption.

Its long positions were concentrated among some of the market’s biggest AI beneficiaries. Public filings showed large stakes in Nebius, Bloom Energy, Sandisk, CoreWeave, SharonAI and IREN as of March 31. By Wednesday’s close, those shares had fallen between by 50% and 78% from recent peaks.

At the same time, software stocks like Adobe that had been used as the short leg of the trade rallied. That meant the fund wasn’t protected by its hedges. Instead, the longs and shorts lost money simultaneously.

“People get over leveraged in this market, and they get seduced by the big returns that some of these companies can deliver,” said Bob Lang, founder and chief strategist at Explosive Options. “If you’re not managing your risk properly, this is the sort of thing that’s going to happen to you.”

As the value of the portfolio fell, the fund’s equity cushion shrank and its prime brokers demanded additional collateral. Raising cash required selling more holdings, adding further pressure to sliding stocks and generating additional losses. What might otherwise have been a painful drawdown became a deleveraging spiral. Ken Griffin’s Citadel hedge fund reached a deal to buy the fund’s publicly traded assets.

“Running somebody out the door like this is as old as time,” Lang said. “I’ve seen it happen a lot in oil markets … there’s a lot of things that are happening underneath the surface that we really don’t know about.”

Momentum crash

The episode offers a stark example of how a hedge fund can sustain devastating losses even when major stock indexes appear relatively calm. The S&P 500 remained near record levels as the damage unfolded, masking one of the most violent reversals in market leadership in decades.

“There is no other way to put it, we just witnessed the largest/ fastest momentum crash in modern history,” Jonathan Krinsky, chief market technician at BTIG, said in a note. “And it wasn’t particularly close.”

Morgan Stanley’s sector-neutral Momentum Index tumbled 17.4% in just four trading days, its worst such decline on record, according to BTIG. The drop surpassed the momentum reversals that followed the dot-com bust, the pandemic shock and the 2022 inflation-driven bear market.

The iShares MSCI USA Momentum Factor ETF posted its best month ever as recently as April, and is now on pace for its worst month, illustrating how quickly one of the year’s strongest strategies turned into one of its weakest.

Clearing event?

AI infrastructure stocks rebounded sharply Thursday as investors increasingly interpreted the previous several weeks of volatility as the product of a technical dislocation rather than a deterioration in the industry’s fundamentals.

With one of the market’s largest forced sellers stepping back, traders rushed into many of the same chipmakers, power companies and data-center plays that had been at the center of the selloff. The tech-heavy Nasdaq Composite jumped for a second day Friday, on track for a weekly gain of 0.9% after suffering steep losses the last two weeks.

Still, not everyone believes the forced unwind marks the end of the AI selloff.

Among the most prominent skeptics is Michael Burry of “The Big Short” fame. Burry has been one of Wall Street’s most vocal critics of the AI boom, arguing that much of the industry’s demand is being sustained by financing arrangements rather than end customers.

Rather than viewing Thursday’s rebound as a turning point, Burry used the rally to add to bearish positions in Micron, the VanEck Semiconductor ETF and Nvidia put options, according to a Thursday Substack post.

“The knee jerk reaction to the Paired Momentum unwind yesterday has been to put it back on today,” Burry wrote. “This was a historic reversal, even more so than what happened 26 years ago,” when the dot-com bubble began to burst in 2000.

Burry said oversold and overbought conditions made a short-term bounce unsurprising, but he questioned whether the trade still had staying power.

“The legs,” Burry wrote, already “they look tired.”