Extreme Fund Returns and Investor Demand for Lottery-Like Funds

Summary

This literature note summarizes research on whether individual investors favor mutual funds that have recently produced unusually large positive returns. The study defines a fund-level MAX measure of extreme gains and reports that funds with higher MAX attract more investor inflows. It attributes this relationship mainly to investors’ preference for assets with a small chance of a large payoff, alongside a tendency to overestimate the likelihood of such outcomes.

The note says the researchers examined alternative explanations. Their tests indicate that MAX does not effectively predict future fund returns, and that its link to inflows is not explained by increased fund visibility. The finding extends research on lottery-like preferences, previously focused mainly on stocks and options, to mutual fund selection. The document offers a summary rather than the paper’s full methodology or data, so it does not provide enough detail to assess measurement choices, sample design, or how broadly the results apply.

Key ideas

• The study uses MAX to measure a mutual fund’s extreme positive returns.
• Funds with higher MAX receive greater investor inflows.
• The proposed explanation is that investors favor lottery-like payoffs and overestimate their probability.
• The note reports that MAX does not reliably predict future fund returns.
• The reported inflow relationship is not attributed to increased fund visibility.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.