Do sell-side analysts say “buy” while whispering “sell”?

Sell side analysts have always been a mystery. Do they recommend stocks with a dual message and a forked tongue—“say-buy, whisper-sell” behavior? One optimistic recommendation regarding a specific stock, for the perhaps less savvy retail investor and another pessimistic recommendation for the more savvy fund manager? The authors of this research argue in the affirmative. Retail investors get the short end of the stick and fund managers get any real insight the analysts may have.

What a bummer.

One caveat, however, the sample is limited to analysts in China.

Do sell-side analysts say “buy” while whispering “sell”?

• David Hirshleifer, Yushui Shi, Weili Wu
• Review of Finance
• A version of this paper can be found here
• Want to read our summaries of academic finance papers? Check out our Academic Research Insight category.

What are the research questions?

1. Provide a quick description of the data and empirical methodology used in this study.
2. Do analysts provide more accurate information to fund managers than to retail investors?

What are the Academic Insights?

1. SOURCES OF DATA AND METHODOLOGY: The analysis was conducted primarily on the CSMAR database. The China Stock Market & Accounting Research (CSMAR) database is a comprehensive financial and economic data source widely used in academic and industry research. It provides detailed data on various aspects of the Chinese stock market and financial institutions such as: stock recommendations: analysts’ public recommendations on stocks were categorized into five standardized ratings: Strong Buy, Buy, Hold, Sell, and Strong Sell. Over 123,000 public recommendations issued between 2010 and 2016, were included such as: analysts’ forecasts of earnings used to gauge the accuracy and optimism of their predictions; fund holdings and trades including semi-annual disclosures of mutual fund holdings, and the number of stocks and industries where the funds invest. Finally, the trading activity of fund managers was determined from changes in holdings between reporting periods and used to calculate the all-important “whisper-sell” and “whisper-buy” signals. Proprietary voting data from the Chinese “Crystal Ball Awards for Sell-Side Analysts” covering the period 2010–2016 was also used. It was supplemented by fund trading disclosures and other public sources of recommendations. Only active fund managers and industries with significant holdings were included to ensure relevance. Simple regressions were used to determine the relationship between the “whisper-sell” behavior of analysts and actual votes by fund managers.
2. YES. The authors developed a proprietary “whisper-sell measure” that quantified the percentage of stocks sold by fund managers with those positively recommended by the analyst. The relationship between the two variables was positive. An increase in whisper-sell behavior (from the 25th to the 75th percentile among peers) was related to a 10% higher likelihood of receiving a top vote from fund managers. Using proprietary data on votes made by fund managers indicated that analysts who privately communicate more accurate information receive higher votes from fund managers. The robustness of results is confirmed across several measures of whisper-sell activity. The authors found that analysts often issue optimistic public recommendations as “buy” or “strong buy”, while privately advising fund managers to sell the same equities. This finding was confirmed in regression analysis that controlled for the volume of reports made and the level of optimism found in the recommendations. Finally, this research found that fund managers who benefit from analysts’ private advice were more likely to reward those analysts in “star analyst competitions”. Stocks classified as “whisper-buy” (recommended to buy privately) tended to outperform “whisper-sell” stocks during the period following the recommendation. This is a result consistent with the hypothesis that private signals are more accurate. In addition, retail investors who followed public recommendations earned lower returns compared to informed managers who acted upon private signals.

Why does it matter?

This research matters primarily for participants in the equity market in China, and for our overall notions of market efficiency on an international scale. The imbalance of information and analyst behavior documented in this study has implications for transparency and efficiency of Chinese markets. Since retail investors tend to make decisions on public signals and those signals are misleading in this case, the implications for retail and small investors are obviously negative. On the other hand, institutional investors and fund managers are in a position to gain from the increased accuracy associated with their position within the dual role of the whisper-sell behavior of analysts.

The most important chart in the paper

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained.  Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.

Abstract

We study here say-buy/whisper-sell behavior wherein analysts issue optimistic recommendations to
attract retail investors while providing more accurate information to fund managers in private, some
times resulting in fund managers selling the recommended stocks. We test whether fund managers
return the favor using their votes for analysts in a Chinese “star analyst” competition. Managers are
more likely to vote for analysts who exhibit greater “say-buy/whisper-sell” behavior toward these man
agers. This suggests that analysts reduce the accuracy of their public recommendations, thereby maintaining the value of their private advice to funds. Our findings help explain several empirical puzzles
about analyst public recommendations.