This study examines how the severity of the local COVID‐19 crisis affected the investment divergence between institutional and individual investors in China. The COVID‐19 crisis significantly increased both environmental uncertainty and fear sentiment. We predict that individual investors, who are at an information disadvantage and rely more on heuristics, are more likely than institutional investors to decrease their investments in stocks of firms headquartered in provinces with more severe COVID‐19 crisis. We find that the number of newly confirmed local COVID‐19 cases is positively associated with the investment divergence between institutional and individual investors. Further analysis shows that the investment divergence is much lower for firms that have higher information disclosure quality, are followed by more analysts and engage Big 4 auditors. We also find that subsequent price reversals are faster for stocks with higher net investments by institutional investors and slower for stocks with higher net investments by individual investors. Lastly, we find that institutional investors increase their investments in undervalued stocks of firms located in provinces with more severe COVID‐19 crisis and firms less affected by the pandemic, whereas individual investors decrease such investments. The results suggest that institutional investors are more sophisticated in identifying undervalued stocks and analysing the impact of the information about the pandemic prevention policies on firms' operations. Our main results hold after a battery of robustness tests.

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