Hedge funds had a strong 2025, but 3 charts show lurking risks that have investors on edge

• Hedge funds saw strong performance and inflows through November 2025.
• But many hedge fund strategies now show high correlation to the S&P 500 index.
• AI-driven stock trends and equity exposure raise risks of sharp losses in a sell-off.

Hedge funds entered 2025 with momentum and optimism.

After a banner year in 2024, Goldman Sachs' February outlook report found "buoyant sentiment" among investors following "unequivocally one of the best years for the hedge fund industry in recent memory." More than 90% of allocators told the bank their hedge fund portfolios met or exceeded expectations — the highest share on record, Goldman said.

Investors have rewarded that confidence with another strong year. Through November, hedge funds gained 10.8% in 2025, according to PivotalPath's composite index, putting the industry on pace to eclipse 2024. Nearly every major strategy has delivered positive returns.

Flows have followed performance. According to hedge fund administrator Citco, $74 billion poured into the industry through November. Hedge fund assets hit the $5 million mark at the end of September, according to industry watcher Hedge Fund Research.

But as the book closes on 2025, risks are emerging that have investors on edge, even amid the strong run.

Several popular hedge fund strategies are exhibiting historically high correlations with the S&P 500, according to a "market risk alert" from industry data provider PivotalPath, which increases the risk of sharp losses in a broader market correction.

"With markets at all-time highs and the economy potentially cooling significantly, elevated correlations may catch investors off guard in an equity sell-off," the report reads.

"A lot of this data caught people off guard," Jon Caplis, CEO of industry research firm PivotalPath, told Business Insider.

Multistrategy hedge funds have been investor darlings in recent years, capturing a disproportionate share of the industry's inflows, primarily because they have delivered uncorrelated returns — and in some periods, even negatively correlated — to the broader market. Now, however, they are showing their highest 12-month rolling correlation to equities since 2011.

Hedge fund allocators "continue to voice concerns around strategy over-exposure to the US large cap equity space," the report says.

While some of the largest multistrategy funds have maintained market neutrality, many others have not, Caplis said.

"The ones who deliberately manage factor exposure have maintained neutrality, though often with additional effort," he said. "For the rest, increasing correlations across risk factors have pushed their portfolios closer to equity markets."

Event-driven strategies face a similar challenge. The category — dominated by merger arbitrage and distressed credit — has suffered from a lack of opportunities over the past year. With M&A and bankruptcy activity subdued, managers have tended to increase equity exposure rather than sit on idle cash, Caplis said.

Underlying many of these correlation trends is AI-driven FOMO — fear of missing out — as investors crowded into AI-adjacent stocks, helping propel the S&P 500 higher in 2025.

"People don't want to underperform the market significantly," Caplis said. "At the end of the day, it's very hard to get away from the AI factor."