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Flashcards in Buy-Side vs. Sell-Side Deck (5)
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1

Differences between Buy-Side and Sell-Side Research

1) Scale and Scope of Coverage.
Research departments at money management firms are typically considerably smaller than those at sell-side firms. Of the 50-100 stocks in a sector that a buy-side analyst follows, the analyst writes reports on roughly 15 stocks at any given time. In contrast, a sell-side analyst usually covers or\Íy one segment of an industry, such as semiconductors or biotech. Reports by analysts at the sample buy-side firm that we studied were shorter
2) Information Sources.
Sell-side: interactions with sales representatives and traders.
3) Private vs. Public Report Dissemination.
Buy-side analysts' research is private, buy-side analysts have been less likely to face such pressure and more likely to provide impartial research.
4) Target Audience.
Buy-side analysts - their firms' portfolio managers. Perspective on companies that is different from the sell-side.
Sell-side research is distributed to buy-side analysts and portfolio managers and to retail investors.
5) Compensation.
Buy-side analysts are rewarded for providing support to portfolio managers and new ideas that differ from the Street consensus. LOWER
Sell-side analysts are rewarded for creating new business for the firm by generating trading volume in the stocks they cover. HIGHER

2

Value added by sell and buy-side analysts and their incentives!

- Buy-side analysts add value for portfolio managers in two ways. 1) They filter the large amount of sell-side research and company news to distill the information into a short monthly report that can be easily used by portfolio managers and their staff. 2) Buy-side analysts provide the firm's portfolio managers with a perspective on companies that is different from the perspective they receive from sell-side analysts
-> willing to make recommendations and forecasts that differ from the Street's consensus and to issue sell as well as buy recommendations

- Sell-side research is distributed to buy-side analysts and portfolio managers at a wide range of firms and to retail investors. 1) Clients reward sellside firms for providing these services by directing trading activity to their firms, which allows the costs of research to be recovered through commissions. 2) Provide value for companies issuing stock by lowering the information costs of investors who are considering a stock and by helping create a liquid market for stocks.
-> public dissemination of analyst research are likely to provide sell-side analysts with an incentive to "follow the crowd

3

Findings about optimism

After controlling for forecast horizon and analyst experience, earnings forecasts by the analysts at the buy-side firm are considerably more optimistic than forecasts made by analysts at the sell-side firms.

4

Whose Forecasts Are More Accurate?

- Absolute forecast errors for buyside analysts have a higher mean and variance than those for the sell-side analysts and are positively skewed relative to the sell-side distribution.
- Absolute forecast errors are an increasing function of forecast horizon and the number of companies that an analyst covers and are a decreasing function of analyst industry specialization, firm size, and firm specialization.
- Absolute forecast errors were lower if they covered fewer stocks, had more experience as an analyst, specialized in the forecast company's industry, and were employed by a relatively large firm.

5

Why Do Buy-Side Analysts Underperform?

1) Analyst Retention. Buy-side firm retained fewer high-quality analysts or more low-quality analysts than the sellside firms.
2) Differences in Analyst Benchmarks. Buy-side firm made no attempt to benchmark its analysts to their sell-side peers.I-* In contrast, sell-side analysts have long been benchmarked to other sell-side analysts.
3) Sell-Side Information Advantage. Information advantage for sell-side analysts from one or more potential sources.
4) Scope of Analyst Coverage. Buy-side firm analysts is that the scope of their coverage prevented them from spending much time on any one stock, which produced shallow analyses.
5) Truncation Bias. Buyside analysts are more likely than sell-side analysts to write reports on stocks for which they have positive views (i.e., are optimistic about) and to stop writing reports on stocks when they find themselves having pessimistic views about the companies.
6) Quality of Analysts Hired.
7) Poor investment Firm Performance. The buyside firm is simply a poorly performing firm, perhaps because of its poor research performance.