Hong Kong-based hedge fund managers are enduring a peculiar form of torment — sitting on paper profits yet hesitant to increase exposure; optimistic about AI yet unwilling to chase the rally.

According to trading desk sources, Nomura quantitative strategist Yoshitaka Suda detailed in an August 24 report his observations from meetings with 45 investors in Hong Kong over the past week. The group was predominantly hedge funds — roughly 70% fundamental long/short, 20% event-driven or quant long/short, and 10% macro funds.

The report falls under Nomura's "Cross-Asset — Japan" research series, focusing on global hedge fund managers operating in Hong Kong with exposure to Japanese equity markets.

Positive Year-to-Date Returns, but July's Drawdown Lingers

The report noted these investors "generally appear fatigued."

Thanks to the rally prior to June, most still hold clearly positive year-to-date portfolio returns. However, the magnitude of July's pullback has driven many to adopt a "wait-and-see" stance.

Only a handful performed well in July, while a few suffered substantially negative year-to-date results due to poor performance both before June and during July.

Notably, even investors at platform hedge funds and multi-strategy funds with strong year-to-date gains are constrained by stringent internal incentive mechanisms — requiring strict control over drawdowns from peak levels. Yet the report shows that during this sharp reversal, almost no one chose to fully liquidate. Nomura suggests one reason may be the scarcity of qualified managers capable of handling Japanese equity mandates.

AI Rally: Cautious Short-Term, Bullish Long-Term, but the "Tug-of-War" Continues

The consensus among most investors is: cautious in the short term, still bullish on AI over the long haul.

Multiple investors pointed out that recent volatility was "entirely supply-demand driven," not a fundamental issue — "not the kind of market you can ride out by sticking to fundamental views."

Long/short funds that performed strongly during the April-to-June AI rally mostly reduced gross exposure during July's drawdown while maintaining overweight positions in AI stocks — though explicitly stating they were "unwilling to add net new buys." Meanwhile, leveraged ETF volumes in Korean equities have declined significantly, and options market makers' hedging demand has stabilized, with implied volatility normalizing — not just for Korean stocks but also for the Philadelphia Semiconductor Index (SOX).

Regarding AI-themed stock rotation, most respondents expect the medium-to-long-term focus to shift toward "AI adopters" (companies using AI to enhance productivity). But before that transition, the market will continue to oscillate between "hyperscalers" (the spenders on AI capital expenditure) and "AI enablers" (semiconductor and data center infrastructure players, the recipients of that spending).

Nomura draws a parallel to the internet bubble era: telecom operators were the "spenders" while communications equipment companies were the "receivers." Comparing price action then versus now, Nomura believes "AI enabler" stocks hold potential for a recovery rally.

Anthropic IPO: AI Stocks May Rise in September, Plunge in October

Many investors are closely tracking Anthropic's mega-IPO. The report notes reports suggesting the listing could materialize as early as October.

Nomura points out that this IPO differs from the earlier massive SpaceX offering in both fundamental aspects and the scale of share allocation to existing investors. But if AI-related stocks follow a similar trajectory to aerospace names during SpaceX's listing, it's not hard to imagine: September sees AI stocks outperforming on IPO roadshow-driven expectations, while October brings underperformance as more investors cash out.

"Once such selling reaches a certain scale, AI stocks face the risk of a stampede by retail investors," the report stated.

Despite July's significant reversal, there has been barely any noticeable increase in stop-loss selling among margin-financed retail investors. Nomura cautions: once margin trade losses breach the -20% threshold, the risk of stop-loss selling escalates sharply and rapidly.

Hyperscaler CDS Spreads Widen, but Share Prices Remain Steady

Currently, almost no investors are explicitly pricing in an end to the AI capital expenditure cycle.

Hyperscaler CDS spreads have widened again recently, yet their share prices remain relatively resilient.

Meanwhile, concerns about rising global interest rates are intensifying. US Treasury yields are climbing, but bond implied volatility remains subdued, unsettling some investors. Inflation expectations in the bond market have rebounded somewhat, though the overall trend remains fairly stable.

The rebound in shipping stocks has also raised some investors' alarms about rising inflation risk. However, after directly comparing container freight rates with shipping stock returns, Nomura concludes the recent rally is primarily driven by short covering — as previously excessive expectations for freight rate normalization are unwinding.

SaaS Stocks Outperforming Amid Rising Rates Unsettles Investors

Concerns about AI disruption risk remain largely unchanged.

In sectors that fell sharply during February's AI disruption sell-off (such as software-related names), some investors have selectively overweighted certain individual stocks, but almost no one is willing to overweight the entire sector on a longer-term basis.

Even for stocks where short covering expanded due to weak fundamental assessments, many investors question whether rebounds beyond already-reached price targets can be sustained.

What particularly unnerves investors: high-valuation SaaS stocks continue to outperform even as rates rise. Nomura notes this phenomenon is especially noteworthy in the Japanese market — before the AI disruption theme dominated, Japanese interest rates were actually an effective explanatory variable for SaaS excess returns, with a strong long-term correlation. However, since July, this relationship has shown a marked divergence, leaving market participants puzzled.

Bank Stocks: Both Value Plays and Hedges Against AI Trades

Views on bank stocks are divided.

The mainstream view holds that after the Bank of Japan's September meeting, there is limited room for further rate hike pricing. But bullish voices argue that if the policy rate rises to 2%, a price-to-book ratio of 2x would not be surprising.

Many investors are simultaneously watching the AI trade's trajectory — if AI stocks reverse again like they did in July, bank stocks may once again attract buying.

Nomura notes that while bank stocks may not necessarily qualify as classic value names, a strategy of simultaneously overweighting value stocks and AI stocks could still be effective. During periods of extreme AI positioning concentration, AI stocks and value stocks may exhibit negative correlation; but since last year, both have actually delivered clearly positive excess returns.

US Midterm Elections: AOC's Odds Surge, Market Yet to React

Investors are showing intense interest in the US midterm elections.

According to betting market data, a divided Congress was previously the consensus expectation, but due to the protracted Iran war, Democrats winning majorities in both chambers has now become the primary scenario.

Nevertheless, there are currently no signs of investors positioning around the midterms — neither in clean energy sectors that typically benefit from Democratic victories, nor in AI-related stocks that could face headwinds from Democratic base opposition to data center construction.

Multiple Hong Kong investors expressed concern: precisely because election developments have not yet triggered noticeable market reactions, a sudden surge in midterm election trading this autumn could once again spark a reversal in AI stocks.

Nomura notes that even if Democrats win both chambers, the Trump administration would remain in power. Additionally, the Democratic Party has yet to form a consensus on its presidential candidate for the election two years from now.

Worth noting: the probability of Democratic Representative Alexandria Ocasio-Cortez (AOC) — viewed by markets as a "worrying" figure — securing the Democratic presidential nomination has risen sharply over the past week or two. But at roughly 20%, Nomura believes excessive concern is unwarranted for now; however, if her support continues climbing, it could dampen market risk appetite.

In contrast, Hong Kong investors show generally low attention to Japanese domestic politics. Nomura points out that with the risk of Finance Minister Satsuki Katayama being replaced having clearly diminished, the market's excessive concern over Japanese political risk also appears unnecessary.

CTAs on Sidelines; Upside Limited Ahead of Jackson Hole

In Japanese equities, high-dividend stocks have continued to outperform during the AI trade reversal (on a value-factor-neutral basis), but Nomura sees limited room for further outperformance, expecting strength to persist until mid-September.

CTAs (trend-following funds) are currently adopting a wait-and-see stance toward Japanese equities. Market makers' gamma exposure has shifted back to net negative.

With the Jackson Hole symposium approaching and event premium rising, Nomura believes upside will remain limited this week.

Nomura maintains its earlier view: a full recovery in fundamentally driven stock selection is more likely to arrive next month, after the summer lull concludes.