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Despite brickbats, sell-siders pick stocks a lot better than buy-siders, study finds

July 1, 2009

For more information, contact: Benjamin Haimowitz,

The pay may still be princely, but in other ways stock analysts have been dealt with roughly during a decade that has decimated their reputations and their ranks alike. And without doubt the biggest blows -- regulatory and otherwise -- have been sustained by so-called sell-side analysts, whose recommendations and forecasts are made available free of charge to a wide audience and not simply to private ears at investor funds.


"Sell-side analysts have been criticized for everything under the sun," says Prof. Boris Groysberg of Harvard Business School, "everything from peddling biases that distort the market to being altogether irrelevant to the movements of the market."


Thus, it  comes as a surprise that a new study presented at the annual meeting of the Academy of Management (Chicago, Aug 9-11) finds that sell-side analysts not only substantially outperformed the market over a period of seven and a half years but left buy-side analysts in the dust as they did so. And, ironically, these achievements came during a period, 1997 through 2004, that ended with the sell-side thoroughly in disrepute.


The new research finds that sell-siders achieved yields that (depending how returns are measured) were two and a half times better or three and a half times better than those of buy-side analysts, who service an exclusive clientele.


In the words of the authors, "Returns from investing in the buy-side firm ratings, particularly their strong buy  and buy recommendations, were consistently lower than those for the average sample sell-side firm...[T]he sell-side firms' out-performance held for six of the eight sample years." Joining Prof. Groysberg in the study are Profs. Paul Healy, Devin Shanthikumar, and George Serafeim of Harvard Business School and Yang Gui of the University of North Carolina, Chapel Hill.


What accounts for sell-siders' surprising superiority in returns? While acknowledging that the study does not definitively answer that question, Prof. Groysberg surmises that it has to do with the pressures and discipline imposed by being in the public eye. As he puts it, "If you're a buy-side analyst only a few people know if you're bad or good. But, if you're a sell-sider, hundreds of clients know; you're rated by Institutional Investor and other publications; the whole market knows. As a result, those who are talented flourish, and the incompetent go elsewhere."


The study's findings, Groysberg says, ought to be a wake-up call for the financial community and, beyond it, the public at large. "The final year covered by our study was 2004, and since then, the sell-side has lost 40% of its workforce, including some of its best people. Yes, there were bad apples, but, on the whole, sell-side analysts make a vital contribution to efficient capital markets, and a combination of regulatory, economic, and industry dynamics has played havoc with that contribution. Hopefully, the innovation and experimentation we are starting to see on the sell-side today heralds a recovery."


The study analyzed stock recommendations over the seven and a half years from July 1997 through December 2004, a period that "covers a wide range of market conditions, including the bull technology market of the late 1990s and the crash in tech stocks in 2000 and 2001." Permitted access to stock recommendations issued by buy-side analysts at a top money-management firm known for its fundamental research, the professors compared the returns gained from following those recommendations to those gained by following the recommendations of close to 12,000 senior analysts at sell-side firms.


"Analysts at the buy-side firm generated an annualized market-adjusted return of 2.3%," the professors write, "suggesting that on average their strong buy / buy recommendations out-performed the overall market index." But among sell-side firms "the strong buy / buy strategy generated statistically reliable market-adjusted returns of 8.1% per year...These findings were not attributable to a few high-performing sell-side firms. The median sell-side market-adjusted return was 7.5%...more than three times the buy-side return. The buy-side firm's strong buy / buy was ranked at the 88th percentile relative to its [sell-side] peers."


To broaden the amount of data on the buy side, where analysts' recommendations are accessible only to their clientele, the professors obtained further information on 1) the performance of portfolio managers at 340 funds who reported that they relied exclusively on buy-side research in making investment decisions, and 2) the performance of 636 funds that relied partly or largely on buy-side research. They then compared these returns to those produced by the recommendations of 2,850 sell-side analysts at 297 investment banks or brokerage firms for the nine years January 1997 through December 2005.


"The mean annualized market-adjusted returns were minus 1.9% for buy-side portfolio managers who relied exclusively on buy-side research and minus 2.5% for the random subsample of buy-side portfolio managers who did not rely exclusively on buy-side research," the professors report. "In contrast, sell-side firms' strong buy / buy recommendations generated average market-adjusted returns of 6.1% per year."


For all that they lagged behind sell-siders in terms of returns, buy-siders did excel in several respects. For one thing, they were less likely to err on the side of optimism, something for which sell-siders have frequently been criticized. Thus, only about 44% of the recommendations issued on the buy-side were strong buy or buy, compared to about 57% on the sell-side. In contrast, 14% of buy-side recommendations were underperform or sell, compared to about 6% of sell-side recommendations.


In addition, the professors found that "buy-side firm recommendation portfolios had significantly lower daily volatility than those for the average sell-side firm," in part due to the fact that sell-sider's "recommendations were tilted towards smaller firms" but also probably because buy-side analysts "were particularly cognizant of the importance of managing daily portfolio return volatility" to minimize clients' "perceptions of investment risk."


The study, entitled "Who Makes Better Stock Picks, the Sell-Side or the Buy-Side?" was among several thousand research reports at the Academy of Management meeting, held in Chicago from August 9 to 11th.  Founded in 1936, the Academy is the largest organization in the world devoted to management research and teaching. It has close to 19,000 members in 102 countries, including more than 10,000 in the United States. This year's annual meeting drew more than 9,000 scholars and practitioners for sessions on a host of subjects relating to business strategy, corporate organization and investment, the workplace, technology development, and other management-related topics

Media Coverage:
Bloomberg Press Service. Best stock picks came from brokerages, beating funds. (Friday, July 31, 2009).

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