Economists have long used measures of public sentiment about the economy to forecast financial outcomes such as consumer spending and economic growth. New research from Penn State, Florida International University, the University of Cincinnati and California State University, Fresno, suggests that public perceptions of the economy may also help explain hedge fund returns.

Timothy Simin, professor of finance at Penn State’s Smeal College of Business, and his colleagues used data from the Thomson Reuters MarketPsych Indices to develop a broad measure known as a macro sentiment index. Their study, published in the Journal of Banking & Finance, examined how hedge funds respond to shifts in public optimism and pessimism about the economy.

Traditional sentiment measures typically rely on surveys or financial market outcomes. The researchers instead used natural language processing to analyse millions of articles from about 2,000 professional news agencies and 800 social media outlets. The analysis assessed the tone of coverage about economic growth, inflation, unemployment, bond markets, politics and social disorder, combining these signals into a single index.

The approach provides a more timely and detailed picture of economic sentiment than conventional surveys. It also captures the news and social media channels through which people increasingly form their perceptions of economic conditions. According to the researchers, this makes it possible to examine not only whether people are optimistic or pessimistic, but also the economic issues driving those views.

The team then measured how sensitive approximately 15,000 hedge funds were to changes in macroeconomic sentiment. Funds whose returns tended to move against public sentiment outperformed those moving with sentiment by about 0.4% per month, equivalent to roughly 5% annually. The relationship remained after accounting for factors including fund size, age, fees, volatility, inflation, default risk and economic uncertainty.

The researchers suggest that hedge funds can benefit by taking the opposite side of sentiment-driven trades. When optimism or pessimism becomes particularly strong, investors may push asset prices away from levels justified by underlying business fundamentals. Hedge fund managers with sufficient expertise and capital can take contrarian positions and potentially profit when prices eventually adjust.

However, betting against public sentiment carries substantial risk. Market sentiment can continue moving in the same direction for an extended period, causing contrarian positions to lose money before any correction occurs. Hedge funds facing investor withdrawals may also be forced to abandon positions at unfavourable times. The researchers therefore argue that higher returns are compensation for bearing sentiment risk rather than simply evidence of superior stock-picking or market-timing skills.

The findings suggest that sentiment expressed through news and social media is more than background noise: it can influence asset demand and market prices. Similar, though weaker, patterns were found among actively managed mutual funds and individual stocks, strengthening the case that macro sentiment represents a broader economic risk factor. The effect was also symmetric, with contrarian funds benefiting when sentiment was unusually positive or negative, suggesting that investors may be rewarded for taking the unpopular side of the market’s emotional swings.

More information: Mustafa Caglayan et al, Macro sentiment and hedge fund returns, Journal of Banking & Finance. DOI: 10.1016/j.jbankfin.2026.107685

Journal information: Journal of Banking & Finance Provided by Penn State