Above and Beyond Recommendations: How Analysts Add Value to Their Fund Clients

Abstract

This paper examines whether the sell-side research industry adds value to its mutual fund clients. I use a novel way to identify the broker-mutual fund network. I find that, within a mutual fund’s portfolio, the stocks covered by the fund’s brokers outperform the uncovered stocks by 6.3% per year, on average. This supports the view that sell-side analysts add value to their clients by helping them make better investment decisions. I further test whether the value added can be attributed to private communications between analysts and their clients. First, I find that, before an analyst releases a negative (positive) recommendation on a stock, her clients sell (buy) significantly more of the stock than do non-clients. Second, among stocks with a strong buy recommendation, those bought by clients before the recommendation announcements earn a 120-day post-recommendation abnormal return that is 1.78% higher, on average, than those sold by clients before the recommendations. These results suggest that brokers help their clients gain an information advantage over non-clients by providing private services and information. Overall, the paper helps to make sense of the existence and size of the sell-side research industry.