Can Hedge Funds Time the Market?

• Author: Michael W. Brandt,Giorgio Valente,Federico Nucera
• Published date: 01 June 2019
• DOI: http://doi.org/10.1111/irfi.12171
• Date: 01 June 2019

Can Hedge Funds Time the Market?

MICHAEL W. BRANDT

†

,FEDERICO NUCERA

‡

AND GIORGIO VALENTE

§

†

Duke University, The Fuqua School of Business, Durham, NC

‡

LUISS Guido Carli University, Department of Economics and Finance, Rome,

Italy and

§

Hong Kong Institute for Monetary Research, Hong Kong Monetary Authority,

Hong Kong

ABSTRACT

We answer the somewhat narrower question of whether hedge funds adjust

their conditional market exposure in response to real-time changes in macro-

economic conditions, and whether doing so improves their performance. We

find that hedge funds differ substantially in their responsiveness to macro-

economic data. The most procyclical market timers outperform their less

active and counter-cyclical peers by over 4% annualized with a risk adjusted

alpha of 5.5%.

JEL Codes: E32; G11; G20

Accepted: 1 December 2017

I. INTRODUCTION

Hedge funds represent the most sophisticated, in terms of information proces-

sing, as well as flexible, with regard to mandate, institutional investors today.

Even so, there is an ongoing debate about whether the risk-adjusted perfor-

mance of hedge funds warrants their relatively high fees. We contribute to this

debate by evaluating empirically whether equity focused hedge funds, as a

whole or certain subgroups, tactically vary their equity market exposure in

response to real-time information about changes in macroeconomic conditions,

and whether doing so improves their performance.

We combine two recent literatures—research on the market timing ability of

hedge funds with research on “nowcasting”changes in macroeconomic condi-

tions. Chen and Liang (2007) find evidence of market timing ability focusing on

a restricted group of hedge funds that are self-proclaimed market timers. Chen

(2007) instead evaluates market timing ability for the “focus market”of hedge

funds, defined as the single security a given hedge fund trades most actively.

1,2

1 More recently, Cao et al. (2013) provide evidence that hedge funds can time market liquidity.

2 There is also a comparatively vast literature investigating the market timing ability of mutual

fund managers (e.g., Treynor and Mazuy 1966; Henriksson 1984; Jiang et al. 2007).

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 19:2, 2019: pp. 459–469

DOI: 10.1111/irfi.12171