When active fund managers deviate from their peers: Implications for fund performance

This paper proposes that the extent to which mutual fund managers’ beliefs deviate from the ex ante unobservable representative beliefs of their peers contains information about their skill. A new measure based on portfolio allocations, peer deviation, is used to capture a fund manager’s divergence from the contemporaneously unobservable beliefs of her peers. The portfolio based on representative beliefs of a group of managers investing in similar assets outperforms passive benchmarks, indicating that they reflect informed beliefs. Fund managers who simultaneously arrive at portfolio selections which, in hindsight, are close to those implied by representative beliefs possess ex ante more skill and exhibit future outperformance. Copycat strategies replicating lagged portfolio holdings implied by representative beliefs outperform the actual portfolio holdings of funds that deviate most, but the outperformance dissipates after two quarters.