Fooled by Randomness: Investor Perception of Fund Manager Skill

Review of Finance, 2017, Vol. 21, No. 2, pp. 605-635. This is the accepted version of doi: 10.1093/rof/rfw011

48 Pages Posted: 9 Sep 2014 Last revised: 2 Apr 2018

See all articles by Justus Heuer

Justus Heuer

University of Mannheim - Finance Area; University of Mannheim - Graduate School of Economic and Social Sciences

Christoph Merkle

Kuehne Logistics University

Martin Weber

University of Mannheim - Department of Banking and Finance

Date Written: February 24, 2016

Abstract

Return-chasing investors almost exclusively consider top-performing funds for their investment decisions. When drawing conclusions about the managerial skill of these top performers, they tend to neglect fund volatility and the cross-sectional information contained in the number of funds and the distribution of skill. In multiple surveys of sophisticated retail investors, we show that they do not fully understand the role of chance in experimental samples of fund populations. Respondents evaluate each fund in isolation and do not sufficiently account for fund volatility. They confuse risk taking with manager skill and are thus likely to over-allocate capital to lucky past winners.

Keywords: Mutual Fund Performance, Skill, Luck, Return Chasing, False Discovery

JEL Classification: G02, G11, G23

Suggested Citation

Heuer, Justus and Merkle, Christoph and Weber, Martin, Fooled by Randomness: Investor Perception of Fund Manager Skill (February 24, 2016). Review of Finance, 2017, Vol. 21, No. 2, pp. 605-635. This is the accepted version of doi: 10.1093/rof/rfw011. Available at SSRN: https://ssrn.com/abstract=2493053 or http://dx.doi.org/10.2139/ssrn.2493053

Justus Heuer

University of Mannheim - Finance Area ( email )

Mannheim, 68131
Germany

University of Mannheim - Graduate School of Economic and Social Sciences

D7, 27
Mannheim, 68131
Germany

Christoph Merkle (Contact Author)

Kuehne Logistics University ( email )

Großer Grasbrook 17
Hamburg, 20457
Germany
+49(0)40-328707-234 (Phone)

HOME PAGE: http://www.the-klu.org

Martin Weber

University of Mannheim - Department of Banking and Finance ( email )

D-68131 Mannheim
Germany
+49 621 181 1532 (Phone)
+49 621 181 1534 (Fax)

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