Investors Turn to Financials as AI Trade Splits Hedge Funds and Mutual Funds

Investors may be divided over how far the artificial intelligence boom can continue to drive stock markets, but hedge funds and mutual funds are increasingly finding common ground in one part of the market: financials.

Both groups increased their exposure to financial stocks in the second quarter, with Goldman Sachs data showing that their bullish positioning in the sector has reached the highest levels in the bank's historical records.

Hedge funds increased their net tilt toward financials by more than 300 basis points during the quarter, taking their exposure to the highest level since before the global financial crisis, according to Goldman chief strategist Ben Snider.

Mutual funds also increased their overweight position in financials, reaching their highest level since at least 2012.

The shift is notable because institutional investors have taken increasingly different positions on the AI trade. Hedge funds have generally maintained significant exposure to companies benefiting from AI infrastructure spending, while mutual funds have not increased their exposure at the same pace as the broader market.

Financials, by contrast, have emerged as a rare area of agreement.

The rotation comes after a strong second-quarter earnings season for many financial companies, which benefited from resilient economic activity, healthy consumer spending and continued demand for financial services.

Goldman's data points to four stocks that have become popular with both hedge funds and mutual funds: Capital One Financial, Corpay, Fiserv and Interactive Brokers Group.

The overlap is spectacular because it suggests the shift into financials is not being driven by a single type of investor or strategy. Capital One is particularly notable. The company appears on both Goldman's list of stocks favored by hedge funds and its list of the largest mutual-fund overweight positions.

Goldman also identified six "shared favorites" among the two investor groups. The broader list includes Capital One, Mastercard and Visa, as well as non-financial companies such as SpaceX, Boeing and Thermo Fisher Scientific.

The pattern reveals a broader investment strategy emerging beneath the surface of the AI debate. Rather than abandoning technology altogether, investors appear to be looking for companies with strong earnings, durable cash flows and exposure to structural growth that is less dependent on the enormous capital spending currently flowing into AI infrastructure.

Financial companies fit that profile in several ways.

Banks and payment companies can benefit from economic growth through higher transaction volumes, lending activity, and investment demand. Payment networks such as Visa and Mastercard also have relatively asset-light business models that can generate substantial cash flow as digital payments expand.

Brokerages such as Interactive Brokers can benefit from increased participation in financial markets, while financial technology and payment-processing companies such as Fiserv and Corpay provide infrastructure for businesses and consumers. That makes financials an attractive alternative at a time when investors are debating more about whether valuations in parts of the AI complex have moved ahead of the underlying earnings.

Goldman's Snider said the performance of hedge funds and their most popular holdings has been closely linked to movements in the AI trade in recent months.

"The returns of hedge funds and their most popular holdings have been closely correlated with swings in the AI trade during the last few months," Snider wrote.

At the same time, mutual funds have increased their holdings of AI infrastructure stocks this year, but their exposure has not kept pace with the weighting of those stocks in major benchmarks.

That difference came with a wide gap.

It means some professional investors are still increasing their exposure to AI companies, but others appear to be reducing the degree to which their portfolios depend on the sector's continued outperformance.

Financials offer a way to diversify that risk without moving entirely away from companies benefiting from long-term economic growth.

The preference for financials is also arriving after the sector's strong earnings performance has provided investors with tangible evidence of profitability. That contrasts with parts of the AI market where investors are paying close attention to enormous capital expenditure programmes and questioning how quickly those investments will translate into revenue and free cash flow.

Among other reasons, the issue is relevant as technology companies spend hundreds of billions of dollars on data centers, chips and other AI infrastructure. If AI-related capital expenditure continues to accelerate, analysts see the companies supplying that infrastructure remaining among the market's strongest performers. But if spending growth slows, investors may favor sectors whose earnings are less dependent on a single investment cycle.

That helps explain why financials have become such a strong destination for institutional capital.

Some prominent investors are already positioning accordingly.

Bill Ackman's Pershing Square increased its positions in Mastercard and Visa during the second quarter, while also adding to holdings in Intercontinental Exchange, the operator of the New York Stock Exchange, and financial information provider S&P Global. The interest extends across different parts of the financial industry, from payments and exchanges to market data.

Still, Goldman cautions that the stocks attracting both hedge funds and mutual funds have historically offered higher returns alongside greater volatility. Since 2013, the bank's basket of shared favorites has generated an annual return of 17%, according to Snider. That performance helps explain the appeal, but it also highlights the risk of crowding. When hedge funds and mutual funds converge on the same companies, the resulting demand can push valuations higher and leave stocks more vulnerable if expectations deteriorate.

For now, however, the financial sector appears to be benefiting from a combination of strong earnings, institutional demand and investor efforts to diversify away from the most crowded areas of the AI trade.

Analysts therefore see the emerging market split not simply as a choice between AI stocks and financial stocks, but a question of how much exposure investors want to have to the AI investment cycle and where they can find earnings growth that is supported by broader economic activity.

Financials are becoming one of the clearest beneficiaries of that search.

But the irony is that while AI has become the defining investment theme of the current market cycle, the strongest area of agreement among institutional investors is a sector that can benefit from the broader economy without having to bet entirely on the next generation of AI spending.