Asset Management and Affiliated Analysts' Forecasts

The interaction between the various departments of a full-service brokerage firm can have positive effects. An asset management department operates the firm's mutual funds and has a need for high-quality information. Thus, the firm's sell-side analysts in the research department are motivated to gather information about particular securities and to use the asset management department as an additional information source. The outcome can be to raise the quality of sell-side analysts' earnings forecasts. In the study reported here, affiliated analysts' earnings forecasts for a security became significantly more accurate as the fund family's percentage ownership of that security increased. Also, the study found a significant positive relationship between the accuracy of an affiliated analyst before the new investment and the percentage of the company's shares acquired by that fund family. The implication is that fund families make the largest purchases of stocks for which their affiliated analysts provided the most accurate forecasts ex ante. These results have implications for investors who are using analysts' earnings forecasts. Full-service brokerage firms offer a wide variety of services to their clients, including investment banking, broker/dealer services, fundamental research, and asset management. The interactions among the various departments of a full-service brokerage firm are of great interest among practitioners, have recently been discussed extensively in the business press, and have been studied by academics. For example, the influence of investment banking on the earnings forecasts and investment recommendations of the firm’s sell-side analysts has been well chronicled.The attention to interactions between the various departments of a full-service brokerage firm often focuses on the deterioration in research quality because of the pressures other departments within the brokerage firm bring to bear on the sell-side analyst. What is often missing from the debate is the notion that positive effects (or externalities) can sometimes arise from these interactions. A potential synergy comes from the demand by in-house asset managers for high-quality financial information within the brokerage firm. The demand for information by the asset management department may motivate the firm’s sell-side analysts to gather information about particular securities and, similarly, to use the asset management department as an additional information source.The evidence on whether the asset management and the research departments of a full-service brokerage firm communicate with each other is limited, although the business press has alluded to such practices. Communication between these two departments has implications, however, for the quality of sell-side analysts’ earnings forecasts and the investment decisions of the asset management department. This study evaluates this issue by examining the association between two variables that capture the information environments of asset management and research—the asset management department’s level of stock ownership and the earnings forecast accuracy of affiliated sell-side analysts.We studied security purchases by the mutual fund families of 17 full-service brokerage firms over the years 1994–2001. We focused on a security purchase in a given period because it provides an unambiguous positive signal about the nature of information within the fund family. We used the semiannual Morningstar OnDisc database to gather information on security purchases by mutual fund families run by brokerage firms; the I/B/E/S database was used to gather sell-side analysts’ earnings forecasts. We found that affiliated analysts’ earnings forecasts for a security become significantly more accurate as the fund family’s percentage ownership stake in that security increases. In particular, we show a significant relationship between affiliated analysts’ forecast accuracy and the fund family’s stock ownership in the highest ownership decile, a level that approximates 1 percent of ownership. We also found a significant positive relationship between affiliated analysts’ accuracy before the new investment and the percentage of the company’s shares outstanding acquired by the fund family. In particular, fund families in our study made the largest purchases in those stocks for which their affiliated analysts were the most accurate ex ante.Overall, our findings are consistent with prior research showing that the various departments of a full-service brokerage firm do not operate independently. We show for the first time, however, that these externalities are not necessarily negative but that synergies can be obtained by providing multiple services within a brokerage firm.