Volatile market condition and investor clientele effects on mutual fund flow performance relationship

•We analyze mutual fund flow-performance (FP) relationship in volatile stock markets.•We find the FP relationship is positive but not asymmetric; no smart money effect.•The positive FP relationship is more pronounced during bull market than bear market.•Market volatility and investor clientele play a critical role in FP relationship.•The findings confirm “house money” effect and investor overconfidence hypothesis.

We analyze mutual fund flow–performance relationship using a novel sample of Chinese mutual funds that trade in a volatile market environment. Consistent with existing literature, we find that the net flow to a fund is positively related to past fund performance. However, the positive flow–performance relationship weakens when the stock market is divided into high and low volatile periods or when funds are divided into good and poor performers. Contrary to previous studies using samples in the U.S. and other countries, our results do not exhibit an asymmetric flow–performance relationship, nor do we find any significant Morningstar rating effect or smart money effect. Furthermore, we find that the overall stock market performance is the primary driving force of flow–performance relationship and the positive relationship is more pronounced in bull markets. Consistent with Thaler and Johnson's (1990) house money effect and the overconfidence hypothesis proposed by Gervais and Odean (2001), this suggests that Chinese mutual fund investors are vulnerable to market conditions. The overall results imply that market conditions and investor clientele differences play an important role in fund investments and flow–performance relationships.