Investor Sentiment Exposure and Hedge Fund Performance

Summary

This research summary examines whether hedge funds’ exposure to changes in investor sentiment predicts subsequent performance. It estimates each fund’s sentiment beta with a rolling 36-month window, forms equal-weighted portfolios by beta, and uses factor-adjusted returns and Fama–MacBeth regressions to assess the cross-section. The sample covers 4,073 US equity hedge funds from 1994 to 2018. Sentiment is measured mainly with the Baker–Wurgler change index, with consumer confidence and a search-based fear measure used for robustness; return tests control for common risk factors, momentum, and illiquidity.

The highest-minus-lowest sentiment-beta portfolio has reported monthly alpha of 0.59%, and the relationship is stronger among funds classified as more capable. The analysis also finds evidence of sentiment timing: estimated timing ability is positively related to both sentiment beta and future fund performance. Controlling for a tradable sentiment factor barely reduces the reported spread, suggesting ordinary exposure to sentiment-sensitive stocks does not fully explain it. These are historical associations and model-based results, not a guarantee of future returns; timing explains only part of the relationship, and the summary notes that further research is needed.

Key ideas

• Funds are ranked by sentiment beta estimated from rolling monthly return regressions.
• The reported highest-minus-lowest portfolio alpha spread is positive after adjustment for common risk factors.
• The beta-performance relationship is stronger among funds classified as having greater management ability.
• Some funds show positive sentiment timing estimates, which correlate with beta and subsequent performance.
• The evidence is historical and does not establish that sentiment exposure or timing will persist.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.