The Impact of Security Analyst Recommendations Upon the Trading of Mutual Funds

Abstract

There is a substantial divide between evidence in the empirical literature and survey evidence in the financial press regarding the influence of sell-side analyst recommendations on the trading of mutual funds. While surveys of fund managers suggest that they assign little weight to analyst recommendations, the empirical evidence is that, in fact, they do alter their positions in a manner consistent with the relative optimism of consensus analyst recommendations. However, the existing empirical evidence, of a contemporaneous association between recommendation levels and portfolio changes at an aggregate level, is not necessarily conclusive of analysts influencing portfolio changes. Our sample, formed on the basis of individual analyst recommendation changes and individual portfolio holdings, allows us to capture the influence of individual analysts, determine whether this influence is persistent and whether highly-rated analysts are relatively more influential. We adopt a research method designed to isolate the incremental impact of analyst recommendation changes, independent of factors which jointly impact upon both analysts and fund managers. This allows us to document a positive association between quarterly changes in mutual fund holdings and changes in analyst recommendations at the individual analyst level. Our results therefore contradict the survey evidence and suggest that the trading of mutual funds is influenced by the recommendations of sell-side analysts. Moreover, we find that the influence of individual analysts is persistent and that analysts included in the Institutional Investor All-American Research Team exert more influence on the trading of mutual funds than their less heralded peers. Persistence in analyst influence is consistent with portfolio managers responding to recommendation changes and inconsistent with investors and analysts merely reacting in the same direction to exogenous information.