While narrative-chasing might follow allocators’ expectations, a recent study proves a lot of credibility can be found in hedge funds’ outside-the-box thinking.
To truly understand public sentiment about the economy, researchers across Penn State, Florida International University, the University of Cincinnati, and California State University, Fresno built a “macro sentiment index”; this used an NLP to process millions of articles from 2,000 news sources and 800 social media outlets to score the ‘tone’ of their coverage, for topics such as growth, inflation, unemployment and political risk.
This index was then applied to around 15,000 hedge funds, and gives marketers a view into how “going against the headlines” could be an advantageous content strategy than a risk that has to be rigorously explained away.
Funds whose returns opposed prevailing public sentiment outperformed those that clung to it closely by about 0.4% monthly, about 5% annually. This was not a fluke, as the same effect held after controlling variables such as fund size, age, fees, volatility and other known risk exposures.
A fund’s sentiment exposure also predicted its performance for around four months forward – a window that could outlast a typical lock-up period.
This finding was explained by the researchers as being a form of compensation for bearing real risk rather than being “free money”; sentiment “can stay irrational longer than an arbitrageur can stay solvent,” contrarian positions may lose money for a long while before intense public moods reverse, and funds facing investor withdrawals can be forced away from their positions at the worst times.
The same pattern is shown (albeit in weaker forms) in mutual funds and individual stocks. This consistency across different sets of assets showed the authors that what they had found was a genuine, priced risk factor, and not simply a quirk only evident in the hedge fund industry.
So, what does this mean for fund marketers?
In the past IR teams that had to explain periods of underperformance relative to general consensus have done so softly, even defensively.
This research, though, can be cited as a serious justification for this occurrence. Similarly, it helps provide an academically-grounded answer as to why a fund’s letter or webinar is supposedly “out of step” with what an investment audience is reading: that sentiment risk is priced, and willing to hold it is the source of the return rather than being evidence of a poor call.
This swerve away from following the headlines applies when making content, too. Marketers that draft commentaries inside the parameters of the week’s dominant news are only producing the “noise” that the market prices away.
The study shows that even if original or contrarian language is not as shareable or clickworthy as domineering economic outlooks, it will be valuable to more sophisticated investors. Seemingly no matter if the overarching mood is overly positive or negative, the discomfort of playing devil’s advocate can be paid back.
Sources
Penn State University, “Q&A: How does public sentiment on the economy affect hedge fund returns?”
Study published in the Journal of Banking & Finance
