Measuring Hedge Fund Timing Ability Across Factors

Abstract

There has been a substantial amount of research on whether mutual funds, and to a lesser extent, hedge funds have the ability to time the market. All of these studies have focused on market timing in the sense that they can correctly position their portfolios for a positive or negative movement in the main equity index. Since many hedge funds are sophisticated investors, one might believe that they engage in timing of more than just a single factor. In this paper, we test this hypothesis directly by expanding the Henrikkson-Merton timing factor to all of the Fama-French factors. We show in simulations that this may lead to incomplete inference about hedge fund timing ability. We also show using a sample of equity hedge fund data from 1994-2009 that although many hedge funds are poor market timers, they have timing ability with respect to other risk factors in the economy. In particular, 13% of Equity Hedge funds have size timing ability, while 9% have value timing ability, and 7% have market timing ability.

Keywords: Hedge Funds, Returns, Market Timing, Factor Analysis

JEL Classification: G0, G10, G11, G23