The Relation Between Securities Firms' Mutual Fund Equity Holdings and their Analysts' Earnings Forecasts

Abstract

This study examines the relation between changes in portfolio composition of brokerage-owned mutual funds and earnings forecasts of sell-side analysts employed by the same firm. We find that these analysts are consistently optimistic for securities that represent new investments for their mutual fund families and consistently pessimistic for those divested. For new investments, optimism becomes significantly more pronounced after affiliated mutual fund managers have added the security to their portfolios. Forecast accuracy begins to significantly decline during periods coincident with the security purchase. For complete divestitures, pessimism is most pronounced in periods that are concurrent with the fund's divestiture, but we document no significant decline in forecast accuracy. In addition, we find that affiliated analysts tend to cease coverage of a security after their brokerages' mutual funds divest. The findings have implications for regulators monitoring brokerage firms' activities, for researchers who use analysts' earnings forecasts as proxies for market expectations, and for investors who rely on sell-side analysts' earnings forecasts.