Buy-side analysts within mutual fund families are able to generate superior risk-adjusted returns, which means they have an important role to play in their organizations, and their skills can positively affect the performance of affiliated funds. Although some portfolio managers benefit by closely following the ideas of these analysts, analysts’ research is generally being underutilized, partly because of career considerations by longer-tenured managers.
The authors extend previous research that assessed the abilities and the roles that buy-side analysts play within fund families. They analyze 68 nontraditional mutual funds that are managed exclusively by buy-side analysts from 14 mutual fund families for the period 2000–2010. They find that buy-side analysts have investment ability because analyst-run funds generate positive and significant benchmark-adjusted performance under two different approaches. They also find that analyst-run funds have higher Sharpe ratios and thus have superior risk–return trade-offs. The authors note that there is persistence in the performance, which is not always the case for manager-run funds, and the performance of manager-run funds tends to be positively and significantly related to the skill level of the fund family’s analysts. Funds that use their analysts’ ideas the most tend to outperform other funds that rely less on their analysts’ ideas.
Paradoxically, the authors find that approximately half of the funds do not tend to follow their analysts’ ideas at all. They consider two possible explanations: analysts withholding valuable ideas and bias by portfolio managers against analyst recommendations. After some investigation, the authors consider only the second reason to be important. Longer-tenured managers are less likely to use analysts’ ideas that are freely shared. The authors attribute this trend as being partly related to career considerations by the managers. Consequently, fund families may not always be optimally using their resources.
How Is This Research Useful to Practitioners?
Fund investors, directors of the fund families, and investment consultants will find the conclusions of this research useful. It seems that investors could benefit from superior performance if the portfolio managers used their analysts’ ideas to a greater extent. Moreover, fund families could enhance performance by further improving the quality of analyst research and by imposing structures and career incentives that encourage a greater use of analysts’ ideas by the fund managers.
How Did the Authors Conduct This Research?
Because analyst funds are not flagged by any classification variables available in the standard mutual fund databases, the authors rely on alternative sources to identify analyst funds. They begin by searching the business press for articles that discuss analyst funds. They identify more than a dozen such articles in which several analyst funds are mentioned by name and some of the families offering these types of funds are identified.
Based on these discoveries, they then search the entire US equity mutual fund universe in the CRSP Mutual Fund Database and Morningstar Direct for occurrences of the word “research” or “analyst” in the fund names. For each fund on the resulting list, they review its prospectus and accompanying statement of additional information filed with the SEC as well as its management profile on Morningstar Direct to verify that the funds are, in fact, managed by analysts rather than portfolio managers. Then they add all Fidelity Select funds, which are managed by analysts on a rotating basis, to their list of analyst funds. The resulting final sample includes 68 analyst funds from 14 mutual fund families. All of these funds are actively managed, and the data span the period from 2000 to 2010.
The authors primarily rely on regression analysis using four databases: the CRSP Survivor-Bias-Free US Mutual Fund database, Morningstar Direct mutual fund database, Thomson Reuters Mutual Fund Holdings database, and CRSP monthly stock data series.
There have been various debates on the abilities of buy-side analysts. The authors find strong evidence that these analysts have investment ability, as shown by the significant abnormal returns the analysts obtain. Analysts’ skills can thus improve performance of the affiliated funds. Despite this result, many portfolio managers tend to underutilize analysts’ research given career considerations. The results are interesting. Although I have concerns that the data used fail to consider the impact of staff turnover at the fund families over time, this research demonstrates that fund investors could be obtaining lower performance because of underutilizing analysts’ ideas. Board members of fund families should pay careful attention to this issue.