A Study Of Analyst-Run Mutual Funds: The Abilities And Roles Of Buy-Side Analysts

College of William and Mary – Mason School of Business

College of William and Mary – Finance

September 1, 2014

Abstract:

We assess the abilities and the role of buy-side analysts within mutual fund families by analyzing mutual funds managed by buy-side analysts from fourteen fund families. Buy-side analysts exhibit investment abilities by realizing positive style- and risk-adjusted returns. Analysts’ skills have a positive impact on the performance of funds from the same family. Although some managers benefit from closely following their buy-side analysts’ ideas, research generated by these analysts is generally being underutilized by affiliated managers. The underutilization is consistent with entrenched managers choosing to forgo some of the analysts’ ideas due to career considerations.

A Study Of Analyst-Run Mutual Funds: The Abilities And Roles Of Buy-Side Analysts – Introduction

Analysts employed by mutual fund families (i.e., buy-side analysts) play an important role in the fund management process. They provide investment recommendations and research support, which potentially have a direct impact on the portfolio decisions and performance of the mutual funds that they support. Assessing the abilities of buy-side analysts and their contribution to fund family performance is important because of the tremendous financial resources fund families invest in their research. If buy-side analysts are shown to not have abilities, then fund families and their investors are better served by eliminating their costly research programs. On the other hand, if buy-side analysts are shown to have abilities, then fund families and investors are better served by fund families leveraging these abilities to the fullest.

However, whether buy-side analysts have investment abilities remains an open question since the previous research that evaluates the abilities of buy-side analysts by studying the performance of investment recommendations of buy-side analysts provides mixed evidence. Specifically, of the three extant papers that follow this approach, each of which analyzes only one mutual fund family, Groysberg et al. (2013) find that recommendations of buy-side analysts have no investment abilities, while Frey and Herbst (2014) and Rebello and Wei (2014)) come to the opposite conclusion.

In this paper, we introduce a novel approach to assess the abilities and role that buy-side analysts play within their families by analyzing 68 nontraditional mutual funds that are managed exclusively by buy-side analysts from 14 mutual fund families. Our approach utilizes the returns and holdings of analystrun funds rather than the investment recommendations of analysts, which have been the focus of previous research.1 If buy-side analysts have investment abilities, then the performance of funds that they manage provides a more accurate indicator of their abilities because it reflects returns from analysts’ actual investment decisions rather than returns from hypothetical portfolios that mimic their recommendations. Further, since analyst-run funds are likely to incorporate the best ideas of a family’s analysts, we can interpret their performance as an upper bound estimate on the profitability of proprietary strategies that exclusively rely on the ideas of in-house analysts. Thus, one of our contributions to this literature is to present more powerful tests of buy-side analysts’ abilities based on a performance measure with a clear and realistic economic interpretation.

Besides providing an alternative assessment of the abilities of buy-side analysts, our second main contribution is addressing whether the investment skills of buy-side analysts have a positive impact on the performance of affiliated funds within their respective families. This analysis is possible because, unlike previous research that primarily utilizes data from only one fund family, our paper studies multiple fund families. This allows us to exploit cross-family variation in the quality of analysts, which we relate with fund performance across the 14 sample fund families. Combining this analysis with a bootstrap investigation, we establish that buy-side analysts have an impact on the performance of their affiliated funds.