Abstract
We examine whether investor sentiment affects hedge fund companies’ decision to start new funds. We find significantly more fund inceptions in hot markets than in cold markets. Moreover, funds opened in hot markets exhibit weaker subsequent performance, higher risk of fraud, and shorter survival. Further evidence indicates that more rookie managers open funds in hot markets, and they “contribute” more to the subsequent underperformance relative to seasoned managers. Investor clientele appears to vary with market conditions, and we find a dumb-money effect for hot-market incepted funds. Overall, inceptions due to high investor sentiment are not in the best interest of investors.
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