Macro Sentiment and Hedge Fund Returns

Abstract

Using a novel dataset, we show media sentiment on growth, inflation, unemployment, and sociopolitical conditions predict hedge fund returns. We blend these into a macro sentiment index (MSI) and show that funds betting against sentiment generate higher risk-adjusted returns. This result is robust to orthogonalizing MSI against popular sentiment indices. We demonstrate MSI as a state variable in Intertemporal Capital Asset Pricing Model (ICAPM) for hedge fund portfolios but not for unmanaged portfolios or individual stocks. Overall, our results highlight differences between media-based and popular outcome-based sentiment measures and suggest a role for sentiment in heterogeneous agent asset pricing models.

Keywords: Hedge funds, macro sentiment, return predictability, risk factors, ICAPM

JEL Classification: G10, G11, C13