Situational Awareness became one of Wall Street’s most closely watched hedge funds in barely two years.

Founder Leopold Aschenbrenner left OpenAI and started the fund with a few hundred million dollars. Lately, it’s managing well over $20 billion.

Investors treated Aschenbrenner like an AI oracle.

Retail investors study his firm’s regulatory filings for clues about where the technology boom was heading. Situational Awareness backed that reputation with large, leveraged positions across the AI supply chain. 

It owns shares in big players like Sandisk (SNDK), Bloom Energy (BE), and Micron (MU).

However, last week, the AI trade cracked.

AI and technology stocks have fallen sharply. The losses hit Situational’s concentrated portfolio, combined with the leverage it took on, forced it to sell some of its positions. 

It eventually sold the bulk of the public-stock portfolio it had financed with debt.

To the market, this looked like a serious test. The Nasdaq 100 briefly entered correction territory. The sudden unwind looked like a warning that one of AI’s strongest believers had lost faith.

And Citadel Securities was waiting on the other side of this collapse.

Days before Situational’s portfolio sale became public, Citadel Securities issued an unusually aggressive Federal Reserve forecast. Its macro team expected the central bank to raise interest rates last week (it did not). 

Citadel Securities argued that investors were underestimating the Fed’s shift. A surprise increase, it said, would restore the central bank’s inflation-fighting credibility and abruptly end the era of signaling every policy move far in advance.

That warning hit the market hard. Higher expected interest rates weigh heavily on growth stocks whose earnings sit far in the future. They also increase the cost of financing leveraged investments.

Some of Situational Awareness’ stocks plummeted by almost half. Sandisk had fallen more than 40% in July, alone. Bloom Energy was down a little over 30%. 

The hedge fund’s AI holdings were falling while the cost and risk of carrying those positions were rising. Since the fund had borrowed from banks to amplify its bets, the losses triggered margin calls.

Those demands forced Situational to raise cash, which in turn required the fund to sell positions into an already weak market. That made those stocks fall even more. 

Citadel Securities had publicly laid out the macro scenario that could create this kind of forced liquidation. Then Citadel emerged as the buyer when the liquidation arrived.

Citadel purchased the portion of Situational’s public-stock portfolio financed with borrowed money. Put simply, it created a problem so it could buy into these AI stocks at a cheaper price.

Citadel manages roughly $71 billion and has a long record of acquiring assets from forced sellers. It could wait for prices to fall, step in when leverage became unbearable, and absorb positions that Situational could no longer finance.

Millennium Management also bid on the portfolio. That interest shows Citadel was buying assets other sophisticated firms considered valuable. Citadel ultimately secured the financed positions.

Citadel understood where the pressure would land and had the capital ready when it did.

Situational Awareness’s collapse looked like a verdict on the AI trade. However, Citadel’s buyout offers investors a more useful interpretation.

Last week’s selloff has nothing to do with the AI market’s collapse. In fact, the largest investors on the planet are trying to buy as much as they can. 

Investors should separate forced selling from deteriorating fundamentals. Citadel used the panic to increase its exposure after prices had fallen.

That makes this selloff a signal that one of Wall Street’s strongest players wanted more of the AI trade, indicating demand is still there. 

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research

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