By Bansari Mayur Kamdar and Nell Mackenzie

LONDON Hedge fund crowding has hit its highest on record, as asset managers have upped their bets on the "Magnificent 7" tech stocks that have juiced up portfolio returns this year, Goldman Sachs said in a report on Tuesday.

Megacap growth and technology stocks accounted for 13% of the aggregate hedge fund long portfolio, twice their weight at the start of 2023, with companies like Microsoft and Amazon.com remaining popular long positions.

This has helped drive outsized returns for the funds.

Returns for the stocks Goldman Sachs has identified as the most popular hedge fund long positions have jumped 31% so far this year, compared to the 19% rise in the benchmark S&P 500 index.

However, as popular positions gain momentum, there is a growing risk of crowding, which reached its highest in the 22 years since Goldman started tracking the funds.

The Goldman report analysed the holdings of 735 hedge funds with $2.4 trillion of gross equity positions. It showed the average hedge fund held 70% of its long portfolio in its top 10 positions.

In stock markets generally, Goldman Sachs said that as the year went on, it was harder to find a contrarian stock trade as most stocks followed the flow of the markets.

The "stock picking" environment has deteriorated and many company names move in the same direction, or are correlated, the bank said.

"The market has had record low dispersion and hedge funds are paid to generate alpha, and excess returns. Unlike long-only that are effectively forced to be indexers," said family office investor Michael Oliver Weinberg.

"So if they are concentrated and making money that's what they should be doing," he added.

The AI frenzy drove the move in hedge funds to tech stocks, but volatility created by GLP-1 drugs like Ozempic led to hedge fund portfolio rotations in the third quarter towards healthcare, the report showed.

Eli Lilly topped Goldman's list for largest increase in hedge fund popularity, benefiting from the rising demand for weight-loss drugs.

Meanwhile, the report also showed short interest in stocks remained low, as hedge funds are increasingly using vehicles like exchange-traded funds and futures, rather than single stock shorts, to hedge their exposure.

The $181 billion in ETF shorts accounted for 80% of gross hedge fund ETF exposure. In comparison, single-stock shorts constitute just 30% of gross single-stock positions, according to the Goldman Sachs data.

Microsoft and Amazon did not immediately respond to requests for comment. Eli Lilly declined to comment.

(Reporting by Bansari Mayur Kamdar and Nell Mackenzie; Editing by Amanda Cooper and Chizu Nomiyama)