Situational Awareness – Leverage blows away another big-bang hedge fund

Situational Awareness is a strange name for a hedge fund and Leopold Aschenbrenner was another technology whiz-kid foraying into fund management. It worked well, till leverage proved too hot to handle.

A hedge fund based on an Essay

It all began with a 165-page essay written by Leopold Aschenbrenner (a former Open AI executive), titled “Situational Awareness.” In his brilliant essay, Aschenbrenner predicts that the global AI scene will transition from the current GPT4 to artificial general intelligence (AGI), and from AGI it will transition to Super-Intelligence. According to Aschenbrenner, this transition may happen much quicker than anticipated and make a lot of the current models look redundant. It is to tap on the opportunities outlined in this essay that the “Situational Awareness Fund” was launched in June 2024.

A lot of things went right for him

To be fair, not only the ideas of Achenbrenner, but even the fund launched in June 2024 was bang on target. The essay did become one of the most read essays in Silicon Valley, and the fund performance was no less impressive. What started as a $300 million fund, grew into a $45 billion fund in less than two years. It was right at the cusp of the AI-driven boom. With stocks like SK Hynix, CoreWeave, Scandisk, Nebius, and SharonAI in its portfolio, the outperformance of the fund was hardly surprising. Even after the correction in recent weeks of up to 60% in most of its portfolio, the portfolio would still have been in a profit. The problem, in this case, was the astonishing 400% leverage.

AI correction eventually took its toll

AI related stocks have corrected sharply in the last few weeks, and that proved to be the undoing for the Situational Awareness Hedge Fund. Most of its top holdings, saw a correction of anywhere between 40% to 60%. In a cash-only fund, that would not really have been a problem. However, the fund was leveraged to the tune of 400% and it needs no genius to figure how a 40% correction would impact a fund with 400% leverage. It was another case of “Genius That Failed.” In the case of LTCM in 1998, the call on Russian bonds was bang on target; just that LTCM did not live to see that day. In the case of Situational Awareness Fund, the entire portfolio was sold in a slump sale to Citadel.

Did Aschenbrenner fail despite being right

Like in case of LTCM, Leopold Aschenbrenner may eventually be correct. The AI correction may just about clean up the froth in the market and we could see the AI stocks rally all over again; probably to fresh highs. The problem with Situational Awareness Fund was not ideas or strategy, but risk management. That was exactly the problem in LTCM too. As Keynes put it eloquently many years ago, “Markets can stay irrational, much longer than traders can stay solvent.” That was the case in this hedge fund too. Your escape routes are closed once the margin calls start; and then it is one short journey downhill. But that is how the money management business works!