Extreme fund performance and investor divergence in beliefs about manager skill

Abstract

Extreme fund performance creates divergent investor opinions about manager skill. We develop a model predicting that this disagreement follows a U-shaped pattern, increasing with both exceptionally good and poor performance. Using a flow-based divergence index and Chinese mutual fund data, we empirically confirm this relationship. We argue that this pattern is driven by retail investors, whose tendency to focus on extreme outcomes amplifies their disagreement. Higher divergence predicts weaker future performance persistence but also helps investors improve their realized returns by allowing them to exit funds before subsequent downturns.