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Inside the black box of
institutional investors in an
emerging market: the role of sell
side analyst outputs
Arit Chaudhury
Institute of Management Technology Ghaziabad, Ghaziabad, India
Role of sell
side analyst
outputs
Received 25 May 2021
Revised 6 November 2021
Accepted 21 February 2022
Seshadev Sahoo
Indian Institute of Management Lucknow, Lucknow, India, and
Varun Dawar
Department of Financial Studies (DFS), University of Delhi, New Delhi, India
Abstract
Purpose – In the backdrop of emerging market setting of India, this study aims to attempt to identify how
Institutional investors use sell side analyst outputs for their decision-making processes in light of inherent
biases in their forecasts and recommendations. The study also conceptualizes the role of internal buy side
teams in the process and try to figure out the key attributes and services provided by sell side analysts, which
provide maximum value to the investors.
Design/methodology/approach – The study is centered upon in-depth semi-structured interviews of
ten institutional investors from top Indian asset management companies covering a wide range of topics tied
back to theoretical explanations. The data collected was transcribed, coded and analyzed using content
analysis to ensure a systematic synthesis of point of view.
Findings – The findings show that internal analyst teams of institutional investors play a dominant role in terms
of validation of sell side analysts’ outputs (given the inherent biases in sell side analyst forecasts). Further, the
engagement of sell side analysts by the investors are determined not only through profitable recommendations but
also on the basis of soundness of the investment rationale along with other services provided. Finally, this study
puts into perspective, the critical role of analyst industry knowledge and access to company management (as
opposed to analyst pedigree and forecast accuracy) for institutional investors decision-making.
Practical implications – The findings of the paper have profound implications for various stakeholders such
as companies, sell side analysts, policy makers, researchers and students of finance in terms of detailed understanding
of investment processes of institutional investors in the context of emerging markets like India, which have a different
legal and regulatory set-up compared to developed markets. The authors also provide a critical perspective through
an intriguing paradox that exists between finance theory and its relevance for actual practitioners.
Originality/value – To the best of the authors’ knowledge, this is the first study in India which look inside
the “black box” of institutional investors and their decision-making process, especially with respect to how
they use sell side outputs.
Keywords Institutional investors, Sell side analysts, Investment process, Interviews,
Emerging market, Semi-structured interview
Paper type Research paper
1. Introduction
The goal of this paper is to investigate how institutional investors consider sell side outputs
in their investment decision-making process. Institutional investors in the context of
Qualitative Research in Financial
Markets
© Emerald Publishing Limited
1755-4179
DOI 10.1108/QRFM-05-2021-0086
QRFM
investment management generally refer to asset management companies such as mutual
funds, insurance companies, family offices and wealth management services. Over the past
decade, development of the capital markets has led to yield hungry investors to shift large
portion of their money from traditional asset classes (such as savings deposits, gold and real
estate) to various active and passive funds (primarily invested across equity and debt) run
by professional fund managers. Global assets under management (AUM) are expected to
rise from US$111tn in 2020 to US$145tn in 2025 [1], while the industry AUM in India rose to
INR 31.4tn at the end of March 2021 compared to INR 10tn in May 2014 [2]. With such an
increasing prominence of institutional investors, understanding of their investment
processes and how they use various outputs like those from the sell side in their decisionmaking process, becomes an addressable issue for researchers and regulators.
However, research concerning the investment decision process of institutional investors
have been sparse, especially in the context of how they use sell side analyst outputs, thereby
raising a valid question on the context within which they make decisions. Much of the
research on sell side outputs have been empirical in nature and generally focused upon
analyst forecasts neglecting the overall value they provide to the institutional investors.
Consequently, there is a lack of understanding on how institutional investors arrive at their
investment decisions and what is the role of sell side analysts in that process.
The primary business model of the sell side is to provide data-driven outputs and
investment advisory to the institutional investors who pay them brokerage for the trades
executed and occasionally, pay direct soft dollars for their advice and outputs. They
communicate their expertise and understanding of the business through regular research
reports on the companies under their coverage. One of the key outputs on the basis of which
sell side analysts are assessed are the earnings forecasts and their accuracy. Most of the
literature on sell side analysts focuses on empirical studies based on archival analyst
forecast data as it is less costly than carrying out an experiment or content analysis of
equity research reports (Bradshaw, 2011). However, there are other important functions that
the sell side analysts perform. Earnings forecasts are means to an end rather than an end in
themselves and analysts provide other services like “industry knowledge” and
“management access”, which are more valuable to investors than just the forecasts (Brown
et al., 2016). Empirical studies on analyst forecasts, at best, provide an association between
the forecasts and various financial parameters, analyst characteristics or market price
behavior, but do not address the question of whether the forecasts are actually useful to the
investors.
There is also little work on how investors perceive analyst forecasts and use them for
their investment decision-making process. Sell side analyst forecasts are known to be biased
due to various reasons ranging from cognitive biases (Dreman and Berry, 2006) and
willingness to cultivate good management relations (Francis and Philbrick, 2006; Lim, 2001;
Richardson et al., 2004; Ke and Yu, 2006). In light of the biases inherent in sell side analyst
outputs, it is imperative that institutional investors do not take them at face value without
validating. All institutional investors have an internal team of buy side analysts who follow
a detailed process and come up with their own investment views, which might or might not
be in line with sell side recommendations. To understand this internal process better, we
need to adopt alternative approaches like surveys and interviews which are expected to
provide more useful insights (Bradshaw, 2011).
We also, could not find any research on how sell side research reports, which contain
detailed explanation of the analysts’ views along with all the forecasts, recommendations
and target prices, are useful to institutional investors. There are only few studies in
literature like Asquith et al. (2005) who perform content analysis of analyst research reports.
This is a surprising gap in literature as research reports contain full descriptions of the
investment thesis along with all the analyst outputs in one place, which can be used as an
initial input by investors in their decision process. Through semi-structured interviews of
institutional analysts and fund managers, we try to map the process of how research reports
along with other outputs and analyst calls are used to make investment decisions and
engage with the sell side analysts (Figure 1).
Moreover, we argue that much of the past research done on the subject is generally
limited to developed markets (US, UK) with very little evidence on developing or
emerging markets, which are characterized by poor investor protections and legal
enforcements. We believe cross country differences and level of sophistication of
financial markets and investors require a concerted study on emerging market such as
India to develop an in-depth understanding of fund management processes. In response
to the above research gap, this study attempts to penetrate the black box of institutional
investors’ investment decision-making, especially on how they use sell side analyst
reports, earnings forecasts and other services provided by them. In fact, till now no study
to the best of our knowledge, has examined these issues in the context of emerging
market of India. The qualitative orientation of this study as opposed to quantitative
orientation in extant literature enables cutting edge insights into above issues with
respect to investment decision-making.
Our study contributes to the existing literature in several ways. First, while prior studies
in the extant literature do shed light on activities of investment analysts (Cheng et al., 2006;
Middleton et al., 2007; Drachter et al., 2007; Imam and Spence, 2016; Coleman, 2014; Brown
et al., 2016), determinants of their investment decisions and practices followed are still
unclear, particularly from the perspective of emerging markets like India where institutional
settings, information flows and corporate governance standards are quite different from
those in developed markets (such as USA, UK, Canada). Our extensive field study thus
represents an important contribution to the existing literature in terms of providing useful
insights to global investors and policymakers into rationales and mechanisms being
currently followed in investment decision-making by fund managers, using sell side analyst
outputs, in an emerging market setting.
Sell side equity research report sent to
instuonal investors. Main contents:
•
•
•
•
Investment thesis
Earnings forecasts
Recommendaon (Buy/Sell Hold)
Target price
Step 1:
Step 2:
Meeng/telephonic discussion of sell side
analysts with fund managers/buy side analysts
to discuss the investment thesis and financial.
Internal discussion among fund
management team regarding sell side
analyst outputs. Key aspects:
•
•
Yes
Role of sell
side analyst
outputs
Convicon in arguments.
Past performance of
recommendaons and error in
forecasts.
Step 5: Connue further engagement
Yes
•
•
Was the basis of
recommendaon sll
sound?
Does the analyst
provide good
management access
and other services?
No
Step 5: Disconnue engagement
Step 3:
No
•
Was the investment
decision profitable?
Step 4:
Make an investment decision: To buy or sell
•
Independent evaluaon by buy
side analyst team.
Management conference calls
and or calls with other
stakeholders to gain further
comfort.
Figure 1.
How institutional
investors engage with
and evaluate sell side
analysts
QRFM
Second, we argue that while sell side analysts, can at times, get away with adverse stock
recommendations results by citing risk factors on their reports, no such leeway is available
to institutional analysts and fund managers’ who are constantly expected to perform or
perish. In an environment fogged with uncertainty and pressure to perform, investment
decision-making becomes a challenging task, particularly, in emerging markets like India
where information asymmetry impedes the ability of fund managers to constantly
outperform their benchmarks. Consequently, institutional analysts have strong incentives to
identify the analyst attributes and the type of analyst services required within challenging
time constraints to meet their goals. Our study identifies the pecking order of such dominant
services and the most desirable attributes of sell side analysts, which create value for
investors thereby bringing important insights to literature from an emerging market
perspective.
To undertake our study, we conduct semi-structured interviews on wide range of topics
with Fund Managers and Sector Analysts representing Top Indian Asset Management
Companies (primarily Mutual Funds, Insurance Companies, Family offices and Wealth
Management Firms) between September 2019 and January 2020. The findings of our study
put into perspective, how investors evaluate sell side analyst outputs, given the inherent
bias in them due to various reasons ranging from cognitive to strategic.
The rest of the paper is organized in the following way. Section 2 discusses the literature
review; Section 3 describes the research design; Section 4 details the sample selection;
Section 5 reports the findings of the interviews conducted; Section 6 summarizes the
discussion and Section 7 concludes with implications.
2. Literature review
Research on financial analysts have disproportionately focused on empirical analysis of
analyst forecast data as it is easily available in databases. Sell side analysts not only provide
forecasts for company financials but also investment advice for buy-side clients in form of a
recommendation often accompanied by a target price (Bradshaw, 2011). However, the key
question is of the reliability of sell side outputs as analysts could suffer from various sources
of bias as well as various conflicts of interest. Forecast accuracy and bias are affected by the
analyst incentives, their skill levels as well as complexities in their job (Kothari et al., 2016).
It has been established in literature that analyst forecasts are generally optimistic (De Bondt
and Thaler, 1990; Ali et al., 1992; Frankel and Lee, 1998; Easton and Sommers, 2007). This
could be attributed to several reasons like cognitive biases (Dreman and Berry, 2006),
analyst self-selection (McNichols and O’Brien, 1997), good management relations (Francis
and Philbrick, 2006; Lim, 2001; Richardson et al., 2004; Ke and Yu, 2006), equity offerings
(Dechow et al., 2000) and alternate communication channels (Berger et al., 2019). On the other
hand, there are also papers exploring the under-reaction of analysts (Mendenhall, 1991;
Abarbanell and Bernard, 1992). Easterwood and Nutt (1999) suggest that analysts
underreact to negative information and overreact to positive information. In some recent
studies, Chang and Hao (2020) show that analysts have a pessimistic bias depending on
relative income growth. Forecast bias could also arise from financial items like intangible
intensity (Ferrer et al., 2020), discontinued operations (Beyer et al., 2021) or even the
difference between pre-tax book income and taxable income (Choi et al., 2020).
To deal with these biases, institutional investors do not take the sell side outputs at face
value but have their own internal buy side teams to carry out an independent analysis.
However, research on performance of buy side analysts are not as prolific as those for the
sell side, as information about buy side research is most private. Buy side analysts have
different sources of information and scope of work compared to the sell side analysts
(Groysberg et al., 2007). Fund managers put more weight on reports by the internal buy side
analysts when the bias of the sell side analyst increases (Cheng et al., 2006). There have been
also been some studies comparing the performance of buy side analysts with those of sell
side analysts. Cheng et al. (2006) find that that sell side analysts are more biased and
optimistic compared to buy side analysts. However, Groysberg et al. (2007) and Hobbs and
Singh (2015) find that sell side analysts provide superior recommendations compared to buy
side analysts. Thus, it is clear that buy side analysts perform a different role compared those
from the sell side and add value to fund managers in their internal decision-making process.
But there is a gap in literature in understanding how buy side analysts take sell side outputs
into account while making their recommendations.
To understand the investment process followed by buy side institutional investors,
rather than empirical studies, alternate research methods like surveys and experimental
studies are more useful and picking up gradually (Bradshaw, 2011). Majority of the studies
on the investment decision-making process has concentrated on analysts and fund
managers in developed markets (Belkaoui et al., 1977; Arnold and Moizer, 1984; Pike et al.,
1993; Barker, 1998; Middleton et al., 2007; Drachter et al., 2007; Imam and Spence, 2016;
Coleman, 2014 among others) with limited evidence in emerging markets. While a plethora
of studies has used surveys to capture the decision-making practices of investors (Arnold
and Moizer, 1984; Pike et al., 1993; Lai et al., 2001; Drachter et al., 2007 among others), other
studies relied on interview technique (Holland and Doran, 1998; Holland, 2006; Henningsson,
2009; Tuckett, 2012; Coleman, 2014; Foster and Warren, 2016) as it tends to provide a
comprehensive and richer insight into observed behavior that may be difficult to gauge
through survey responses or any quantitative methodologies.
In one of the earlier works on investment decision-making processes, Arnold and Moizer
(1984) conduct a comprehensive survey of 505 UK investment analysts between the years
1978 and 1981 to understand the valuation techniques, forecast methods used and sources of
information. They found that while analysts accorded perceived importance to annual profit
and loss statement, balance sheet and interim results, discussions with the company
management turned out to be a significant source of information. In the same vein, Pike et al.
(1993) investigated the investment processes through surveys of UK and German analysts
and found that there was little change in share evaluation techniques over the past decade
despite introduction of new technologies and increasing market efficiency. Second, the study
reported that German analysts pay more attention to new non-financial company
information specifically related to research and development or product quality nature
compared to their UK counterparts. Drachter et al. (2007) tries to assess the behavior and
attitudes of German mutual fund managers using a telephonic survey. The results indicate
that the fund managers’ behaviors vary considerably with the characteristics of the funds
and the characteristics of the fund company. While larger funds considered conversations
with company executives to be an integral part of fund management process, smaller funds
tend to be divided in their importance to conversations with company management.
Likewise, a number of studies have been conducted based on interviews with investors in
developed markets. For example, Holland and Doran (1998) in their study interviewed 27 of
the largest UK financial institutions to understand influence advantage from the
relationship with the investee companies in their portfolio. The results of the study showed
that relationship information helped stock valuation and portfolio decisions irrespective of
the valuation method used. Lai et al. (2001) also examined the investment practices and
processes of 77 Malaysian institutional investors during bullish and bearish periods and
concluded that investors relied mainly on fundamental analysis (complemented by technical
analysis) to make investment decisions during both bullish and bearish periods.
Role of sell
side analyst
outputs
QRFM
Holland (2006) again in a study conducted interviews of 40 fund managers representing 35
of the largest UK funds for the period between October 1997 and January 2000 find that fund
managers generally resorted to private meetings with company management to understand
value of intellectual capital and intangibles while valuing the companies. Coleman (2014)
conducted semi-structured, interviews with 34 fund managers across Istanbul, London,
Melbourne and New York. The key findings indicated a preference for qualitative analysis,
attitudes, heuristics and social networks over conventional quantitative data and analysis.
In the emerging markets context, most studies are based on investment decisions of retail
investors, more on the investment tools and less on the process. Mohamad and Perry (2015)
try to develop a framework for investment processes followed by fund managers in
Malaysia. Jaiyeoba et al. (2018) survey four retail and four institutional investors in Malaysia
and try to understand their company selection processes and investment decision
challenges. The country governance factors, which affects earnings efficiency, might also
play an important role in an emerging markets context (Kamarudin et al., 2014, 2016).
However, we could not find any study which looks at how institutional investors in
emerging markets use sell side outputs in their decision-making. Brown et al. (2016) carried
out a survey of 344 buy-side analysts from 181 investment firms in developed markets and
found that “industry knowledge” and “access to company management” are the most
important services to the investors provided by the sell side. However, it does not deal with
how internal buy side teams consider sell side outputs and how they are used to engage with
the sell side analysts. Most of the previous studies focus on the empirical properties of sell
side analyst forecasts, while research on how buy side investors actually use these and other
sell-side outputs in their actual investment processes, present a significant gap. Qualitative
studies on the processes followed by institutional investors, especially in the context of
emerging markets like India, which have a different legal and governance framework
compared to developed markets, are also few and far between. Our work explores these
questions in greater depth on how sell side outputs are used by institutional investors, what
role is played by buy side analysts in the process, and finally, what are the key sell side
services and attributes which provide maximum value to institutional investors,
particularly in the emerging market context of India.
3. Research design
While the extant literature specifies a plethora of methods for data collection such as indepth interviews, observations, surveys and document review Marshall and Rossman
(2011), this study uses an semi-structured interview-based approach to achieve the
objectives concerning how institutional investors use sell side outputs for their decisions. In
this case, the study conducts in-depth semi-structured interviews motivated by grounded
theory approach (Strauss and Corbin, 1990; Glaser, 1992). In following this approach, we
tend to examine the subjects in a natural setting and then interpret the gathered field notes,
conversations, meanings and actions. Semi-structured interviews lie between the continuum
of unstructured and structured interviews. While unstructured interviews are generally
interview and context specific, structured interviews involves a series of pre-established
questions to be answered by the interviewee. In between them, semi-structured interview set
up involves questioning based on interview guides containing identified themes to elicit
detailed responses in a systematic manner and at the same time allowing interviewee to
command flexibility in responding the way they like. According to Qu and Dumay (2011),
semi-structured interviews are a popular method of qualitative research, which contains
guided questions which helps direct the conversation toward the themes the interviewer
wants to investigate. It is also flexible, accessible and intelligible and, more important,
capable of disclosing important and often hidden facets of human and organizational
behavior. Similarly Kvale and Brinkmann (2009) in their study observe that semi-structured
interview is the most effective and convenient means of gathering information. For our
study, we develop an interview guide with respect to investment practices and determinants
of stock recommendations of institutional investors. Our interview guide contains the
following sequence of guided questions to the institutional investors to direct the
conversation around certain chosen themes. They were structured in line with the following
research questions (RQs):
RQ1. How important for you are sell side analyst outputs and their earnings forecasts?
RQ2. How do you use various sell side outputs to arrive at your investment decisions?
RQ3. How do you decide to evaluate and engage with the sell side analysts?
RQ4. What role does the internal buy side analyst play compared to the sell side
analysts?
RQ5. Which are the most important attributes of a sell side analyst?
RQ6. Which activity of the sell side analyst provides most value to your investment
process?
The questions pertaining to above sequence of topics were open ended in nature to allow
respondents to express themselves in their own way. The interviews went on for
approximately one hour each with each interviewee being provided with same set of
questions. The data collected from the interviews were transcribed, coded (Glaser, 1992) and
analyzed using content analysis wherein the dominant messages, themes, viewpoints and
facts within the text were duly identified. This ensured a systematic analysis of the
responses of the interviewees and their support for a particular point of view. Post this
systematic analysis, findings were formalized giving detailed insights into investment
decision-making processes and viewpoints of interviewees. To ensure integrity of our
qualitative research, the interview data was diligently verified with written notes and
documents for confirmation on accuracy.
4. Sampling
4.1 Sample selection and characteristics
The study is based on semi-structured interviews with a sample comprising fund managers
representing leading Indian institutional investors from some of the top mutual funds,
insurance companies, family offices and wealth management firms in India. A total of 10
interviews were conducted with professionals who control funds with AUM (assets under
management) ranging from $300m to $4bn, all in leadership or key decision-making
roles. The interviewees were selected through recommendations from investment
consultants, referrals as well as professional contacts of the co-authors. There were a total of
9 male and 1 female participants, with an investment experience of between 15 and 25 years
with all the participants having a professional qualification of MBA, CA or CFA.
The approach was that of a guided semi-structured interview, in which participants were
given the assurance of confidentiality to understand how the institutional fund managers
perceive sell side analysts and use their outputs. This allowed the participants to provide
their own insights and additional information around the various themes and allowed
deeper exploration of their decision-making process (Hermanson et al., 2012; Coleman, 2014).
Role of sell
side analyst
outputs
QRFM
The sample of 10 interviewees is admittedly small compared to the universe of domestic
institutional investors who invest in the Indian markets (a total of 41 mutual funds, 24 life
and 33 general insurance companies, and several family offices and wealth management
firms as of 2021). However, after conducting about 6–7 interviews, we found that we found
little additional insights on the themes of our interest and reached the point of diminishing
returns (Hermanson et al., 2012). Also, according to Malterud et al. (2016) and Jaiyeoba and
Haron (2016), a sample of 6 to 10 participants may be sufficient in an interview based study
if the aim is suitably narrow, participants are more specific to the research question and
analysis involves longitudinal in-depth exploration. We believe our sample size of 10 was
sufficient enough to validate conclusions as saturation was reached on key issues with
additional interviews unlikely to yield any new information (Guest et al., 2006).
One drawback of our process is that the sample could be biased since it was based on
self-selection of the co-authors. But this aspect was more or less mitigated since all the
participants were senior practitioners, in leadership roles with a minimum experience of
15 years, and thus provided many meaningful insights in the setting of a free-wheeling
discussion.
Table 1 provides background information and key characteristics of our sample.
5. Findings
Following the research design section wherein interview data was collected, transcribed,
coded and mapped into themes, this section discusses the broad findings of the study
conducted. The analysis of the data revealed the following summary findings based on
Type of employer
Table 1.
Characteristics of
interviewees
No.
Mutual fund
3
Insurance
3
Family office
2
Wealth management
2
Assets under management (US$m)
% of sample
upto 500
30%
between 500 and 1000
30%
between 1000 and 2500
20%
> 2500
20%
Size of investment team members
% of sample
1-3
20%
3-5
20%
5-10
40%
>10
20%
Gender
% of sample
Male
90%
Female
10%
Educational qualifications
% of sample (including dual qualifications)
MBA
80%
Masters in Finance
20%
CA
30%
CFA
30%
Job experience (mean years)
16
20.33
19.5
19
Notes: MBA – Masters in Business Administration, CA – Chartered Accountant, CFA – Chartered Financial
Analyst
collating the responses from the interviewees and arranging them in line of the research
questions identified above:
RQ1. How important for you are sell side analyst outputs and their earnings forecasts?
Most respondents agree that sell side analyst outputs, specifically earnings per share (EPS)
forecasts are something that they consider while researching a company for investment. One
key takeaway from our unstructured interviews is that analyst forecasts and other outputs
act only as a preliminary check before the internal team does their own analysis. Hence, the
investors do not take the sell side outputs at face value. Also, rather than on a regular basis,
analyst outputs are more useful when a new company is being analyzed. Analyst forecasts
act as a guide, when institutional investors are researching a new investment idea for which
they use sell side views as an initial guidance:
When investigating a new company, rather than starting from scratch, our internal team considers
the sell side forecasts as an initial indication of the worthiness of the idea – Fund manager,
insurance company
However, analyst EPS forecasts are not the only thing that helps them form an investment
idea. The recommendation and target price also plays an important role in validating the
forecast:
Along with earnings forecasts, the upside in the target price and the strength of recommendations
also tells us about the conviction of the sell side analyst – Head (investments), family office
Individual sell side analyst forecasts are also useful to compare the divergence from
consensus. A few respondents reported specifically picking up those analyst outputs, which
vary from the consensus. This often allows new insights that might have been missed by the
consensus:
Analyst outputs are more useful if they differ from the crowd. We pay more attention to those
forecasts which vary from consensus. We look at the numbers and investment rationale more
closely in those cases – Partner, wealth management
We pay more attention to analyst views which disagree with us, rather than those who agree –
Senior fund manager, insurance company
Another important issue was the possible bias in analyst forecasts due to the fact that their
reports are public, and they need to cultivate good management relations to retain
accessibility. Institutions are aware of this fact and thus prefer independent sell side houses
or avoid sell side analysts involved in recent deals:
We seek an independent and unbiased view from analysts, which, understandably might not be
always possible due to various reasons. No one blindly trusts analyst forecasts and
recommendations without verifying their rationale. We prefer to work with independent
brokerages, but there are few such firms in India – Director, wealth management.
To summarize, institutional investors agree that sell side analyst outputs are an important
tool to evaluate investment ideas. However, they use it to further validate their own ideas
and not as a direct investment tool, as there could be various sources of bias. Different
analyst forecasts are compared and analyzed by the internal buy side teams which carry out
their independent analysis:
RQ2. How do you use various sell side outputs to arrive at your investment decisions?
Role of sell
side analyst
outputs
QRFM
Even though earnings estimates of sell side analysts are the most widely tracked, a sell side
analyst provides views on several other variables such as stock recommendations, growth
projections, target prices and also other qualitative factors (Bradshaw, 2011). All these
variables are captured in the analyst research reports, which are distributed to the
institutional investors in return for future trading brokerage and, sometimes, soft dollars.
Analyst reports are also of different types. There are recurring reports covering
quarterly results and upgrades/downgrades. There are also initiating coverage reports
which contain the detailed investment thesis when the company is brought under coverage
the first time. We asked our interviewees how useful are these research reports to make their
investment decisions:
Sell side analysts generally cover companies in great depth in their reports along with the full
investment thesis and financial forecasts when they initiate coverage. It is very useful to know
about a company in depth – Fund manager, mutual fund
Sell side analysts, after publishing their reports, often follow up with the investors with a
client call, explaining their investment thesis, forecasts and recommendations. This is partly
because it is not possible for institutional investors to go through all sell side reports in
detail. This is also useful for investors to understand the report better as well as form an
internal view about the investment. However, what came out from our conversations, was
that a call or meeting with the sell side analyst to discuss his/her report often provides new
or even critical insights which might not be present within the report itself. This could also
be important, due to various inherent bias in analyst outputs, as discussed earlier, which
might necessitate direct interactions to examine the validity of those outputs (Berger et al.,
2019):
A call or meeting with the sell side analyst is often necessary to understand and validate the key
points discussed in his/her research report and to test the analyst’s conviction. A research report
could be biased since the analyst cannot write unflattering words about the company in an open
document. They are more forthcoming in a direct conversation – Director, wealth management
Thus, the value provided by the sell side does not only end at sharing earnings forecasts and
recommendations but also explanation of their investment arguments on basis of which the
institutional investors’ internal team can take a decision.
Finally, we found that sell side analysts provide additional services to the institutional
clients by also setting up management meetings, conferences and investment seminars:
Interaction with the company management is very important to understand the business outlook,
the future growth trajectory and also get more detailed business insights. It also helps in validating
the sell side story. This is more important for new companies rather than companies we already
know about. – Fund manager, insurance company
RQ3. How do you decide to evaluate and engage with the sell side analysts?
We tried to understand the process by which the institutional investors engage with and
give business to the sell side analysts. This also allowed us to create a process map of their
activities and how they are linked to the evaluation of sell side analysts (Figure 1).
The discussions with the sell side analysts based on their reports and follow up calls/
meetings also serve an important purpose in evaluating them for future brokerage business.
As there could be several sell side analysts who are servicing a client, investors often create
a pecking order of top analysts with whom they interact with more closely and provide more
business:
There are dozens of brokerages and it is not possible for us to entertain each and every analyst. We
create a list of high performing analysts whose advice we pay close attention to. Most of
our brokerage business is distributed among the top 5-10 sell side houses based on analyst
performance – Senior fund manager, mutual fund
The engagement of sell side analysts are based on quality of their advice and profitability of
their recommendations. Once a sell side report is released and discussion with the analyst is
completed, there is a deliberation within the internal team to discuss the idea. The internal
discussions critically evaluate the strength of the sell side analysts’ investment arguments
and financial forecasts, as well as their past track records and forecast errors. It is often
followed by more primary research and management interactions which the sell side
analysts help set up:
What determines the usefulness of the sell side analysts are not only the hard outputs but also
services like access to management and also other stakeholders and industry bodies. It helps us form
an independent view about the company if we decide to invest – CIO, family office
After evaluating the analyst reports, internal team discussions as well as management
meetings, the institutional investors arrive at a decision on whether to invest in the
company. One of the main parameters in evaluating the sell side analyst is definitely the
performance of the recommendations. However, we find that even if the recommendation
turns out not to be profitable, institutional investors can continue engagement with sell side
analysts if their recommendations were based on a strong rationale:
We understand that markets don’t always react the way we expect and same with company
forecasts. However, if a sell side analyst’s views were based on a strong investment argument and
rationale, even if the market moves against it, we see no reason in penalizing him/her. An analyst
also provides other useful services – Senior fund manager, mutual fund
Based on our discussions with several investors, we mapped the investment process of the
institutional investors and how they engage with the sell side analysts (Figure 1). The sell
side analyst outputs are discussed, evaluated and scrutinized by the internal team, backed
up with calls and meetings both with the analyst and company management, before an
investment decision is taken. Performance of the recommendations, investment rationale
and others types of services provided decide the engagement level with the analysts:
RQ4. What role does the internal buy side analyst play compared to the sell side
analysts?
Every large institutional investor has an internal buy side investment team comprising of
analysts, fund managers and dealers working under a research head or Chief Investment
Officer. The main question we wanted clarity on is that how the role of the internal buy side
analyst differs from that of the sell side.
The buy side investment team of an institutional investor often contains a small team of
research analysts compared to a dedicated analyst for each sector in the sell side. Thus buy
side analysts vary significantly in scope and coverage of companies compared to the sell
side (Grosberg et al., 2007). Sell side analysts also have a deeper understanding since they
cover less number of companies compared to the buy side (Brown et al., 2016). The main
difference is in the composition of the team where sell side analysts cover companies sectorwise, while a buy side analyst can cover companies across multiple sectors:
We have a team of 5 analysts covering more than 100 companies and multiple sectors between
them. Whereas the average sell side house has a team of at least 20 based on sectors under
Role of sell
side analyst
outputs
QRFM
coverage. Definitely the sell side analysts have a deeper knowledge base since they are sector
specialists – Senior fund manager, Insurance company
However, this does not mean that the job of a buy side analyst is “shallower” compared to
that of the sell side. While a sell side analyst is evaluated not just on their financial forecasts
and recommendations but also on factors such as industry knowledge and management
connect, a buy side analysts’ performance depends only their profitable recommendations,
which results in a positive “alpha [3]” to the fund. This means that buy side analysts have
more stake in their decisions and have their “neck in the line”. This is particularly true for
mutual funds for whom fund performance even in the short term is key to continuing
business:
This is a competitive industry which places emphasis only on NAV [4] performance. A buy side
analyst clearly has his task cut out. Repeated wrong calls would is not something which is
acceptable – Fund manager, mutual fund
The increased stake in investment recommendations for a buy side analyst means that
every decision has to be carefully evaluated and analyzed from different angles before
taking a final call. Hence, the buy side analysts play an important role in scrutinizing the
forecasts and recommendations of the sell side analysts to zero in on a decision:
Our internal analyst team meets with different sell side analysts, scrutinizes their investment
thesis, financial forecasts and often meet the management before taking a final call. Thus, our
analysts aggregate the views of various stakeholders before taking an independent call based on
their own judgment, for which they are accountable – CIO, family office
This is particularly important, as a sell side analyst could suffer from several sources of bias
which is explored in depth in literature, starting from cognitive biases (Dreman and Berry,
2006) to willingness for good management relations (Francis and Philbrick, 2006; Lim, 2001;
Richardson et al., 2004; Ke and Yu, 2006):
A sell side analyst has different biases and conflicts of interest due to business reasons because of
which their forecasts and recommendations cannot be taken at face value. Our internal analyst
team can take more unbiased calls – Senior fund manager, insurance company
Thus, we find that buy side analysts play an important role in validating the views of the
sell side analyst and mitigating the bias in their outputs and make their own independent
judgment on the investments. The stakes are also higher for a buy side analyst:
RQ5. Which are the most important attributes of a sell side analyst?
As institutional investors deal with several sell side analysts, we seek to better understand
which qualities of an analyst provide maximum value to them. We asked the interviewees
about the attributes that are used by them to rank and evaluate the sell side analysts to
decide the level of engagement with them. They were asked to rank the attributes of a sell
side analyst on a 0 to 5 scale, with 5 being the most important and 0 being the least. Each
attribute is scored independently. The average scores are then compared to rank the
attributes in order of importance (Table 2).
Our interviews highlighted on the importance of industry knowledge of sell side analysts
as a top attribute in terms of usefulness to institutional investors (Table 2). In fact, this
observation underscored an important theme related to engagement of sell side analysts.
Most of our interviewees’ stressed upon the role of previous industry experience of sell side
analyst, in fact someone who has worked previously in a particular industry was perceived
to be more useful than others with no industry experience. There was a widespread belief
that sell side analysts with past specialized industry experience are better equipped to
understand industry dynamics and deal with management rhetoric:
Sell side analysts with past stints in the industry are rated highly by us particularly for
specialized sectors like Pharma or Oil and Gas. We prefer to interact with analysts who have
worked in that industry, they give us a more grounded view of the industry dynamics and
company’s competitive positioning. – Partner, wealth management
Role of sell
side analyst
outputs
The second most attribute of an analyst was “accessibility and quick response”. We found
that it is important for the sell side analysts to be responsive to calls and requests of
institutional investors. This is because investors have to act within a limited time period
when opportunities are present and hence timely advice from sell side analysts is critical:
We often need the sell side analysts to quickly crunch some numbers for us since opportunities in
the markets are short lived. So prefer to work with analysts who are fast and accessible to allow
us to quickly take decisions – Fund manager, mutual fund
Surprisingly, personal compatibility came out to be the third more important attribute
desired by institutional investors. Though this does not necessarily mean favoritism, a sense
of camaraderie clearly has a role to play:
We prefer to work with good sell side analysts with whom we are comfortable – Head (investments),
family office
However, the years of work experience does not matter as much as industry knowledge and
was ranked fourth among six attributes (Table 2). It is clear that more years of experience is
not necessarily a highly desired attribute and also, being more experienced might not
correlate with higher industry knowledge.
Analyst rankings (Institutional Investor/Asiamoney, etc.) or pedigree (big or small
brokerage) are not given any importance by the institutional investors. This means that
investors carry out their own independent evaluation of sell side analysts and do not rely on
external attributes. Surprisingly, we found that analysts from smaller houses can in fact be
more useful than the more pedigreed ones:
We evaluate sell side analysts based on the value they create for us and not on where they work.
Some analysts from smaller brokerages cover more small and micro market capitalization
companies which are more useful to us. Bigger companies are anyway well researched – Senior
fund manager, insurance company
Finally, hard skills of an analyst like analytical and communication skills do not appear to
play a role, since, at this level, such skills are not such an important differentiator:
Sell side analyst attributes
Industry knowledge
Accessibility and quick response
Personal compatibility
Years of work experience
Analytical and communication skills
Ranking/pedigree
Average score in terms of usefulness for investment decisions
4.7
4.5
4
3
1.9
1.8
Note: The above ranking is based on average scores (0–5) based on importance by the interviewees for
each analyst attribute. Every attribute is scored independently
Table 2.
Sell side analyst
attributes
QRFM
RQ6. Which services of the sell side analyst provides most value to your investment
decisions?
Along with the individual analyst attributes, the kind of services provided by the sell side is
an important parameter for engagement. This is because even if a sell side analyst has some
highly desirable attributes, the client policies and infrastructure provided by brokerages
also play an important role ensuring quality of service. We tried drafting a perceived
ranking order of sell side services from the point of usefulness to investment decisionmaking by questioning the institutional investors (Table 3).
Our interactions clearly suggest “access to company management” as the most useful
service input for decision-making process of institutional investors (Table 3). Our
interviewees stressed upon the fact that given the large number of companies they cover, it
becomes virtually impossible to build relations with each and every company management
and therein comes the significance of sell side analysts. Sell side analysts acts as
intermediaries between the company management and fund managers/sector analysts and
can timely arrange meetings and conference calls:
I would rate access to company management very highly while evaluating the sell side analyst. It is
not possible for us to maintain so many company relationships. We depend more upon the sell side
analysts’ access to management for detailed meetings and calls. – Partner, wealth management
We also found that technical factors such as markets and trade information play have an
important role for institutional investors, which is the second most important service
(Table 3). This means that a sell side analyst has to not only provide fundamental research
about the companies but also keep track of technical and trade related information. While
this service is sought by all institutional investors, we found that mutual funds find this
particularly important:
Our industry is highly competitive. It is important to be aware of what our competitors are doing,
and what they are buying and selling. We rely on the sell side to provide us fast and accurate
trade information - Fund manager, mutual fund.
The third factor which we found most important in the packing order is the depth of
coverage universe, in other words, number of companies tracked. This tallies with what
found earlier in RQ5 that coverage of smaller market capitalization companies are more
useful to institutional investors, as larger companies are well researched. Clearly, here
smaller brokerage houses have a niche.
One more important conclusion we found is that the main hard outputs of the sell side
analysts, that is, their research reports and financial models, only lie somewhere in the
Sell side analyst service
Table 3.
Sell side analyst
service usefulness
Access to company management
Markets and trade information
Coverage universe
Quality of research reports
Quality of financial models
Accuracy of forecasts
Frequency of reports and mailers
Average score in terms of usefulness for investment decisions
4.6
4.1
4.0
3.9
3.3
2.9
2.8
Note: The above ranking is based on average scores (0–5) based on usefulness by the interviewees for each
kind of service. Every service is scored independently
middle of the pecking order (Table 3). We found that though these outputs are important,
they do not necessarily have to be very detailed:
Some analysts provide more detailed research and models compared to others, but short and
simple reports and models are something which we prefer. Complexity might sometimes hinder
clarity – Senior fund manager, insurance company
Lastly, past forecast accuracy and frequency of research reports are considered relatively
less useful for investment decision-making from the perspective of institutional investors.
Again, the underlying theme here is that fund managers do not much care for past forecast
accuracy and are rather seemingly more concerned with value addition done by sell
side analysts in terms of access to management and trade information. We do find this at
odds again with tenets of academic theory wherein forecast accuracy of sell side analyst has
much more research coverage than other services.
6. Discussion
Through carrying out unstructured interviews of different categories of institutional
investors in India, we uncover various facets of how these investors use sell side analyst
outputs to drive their investment decisions. Various categories of institutional investors:
mutual funds, insurance companies, wealth managers and family offices are studied
through six different guided questions ranging from how important are sell side analyst
outputs and how they use them, to the processes they follow in their internal teams and
engagement of sell side analysts and finally what type of attributes and services are most
important for sell side analysts.
We find that institutional investors do pay attention to sell side outputs such as earnings
forecasts and recommendations, but that solely does not influence their investment
decisions, given the inherent bias in those outputs. Analyst reports and forecasts are more
useful mainly for new companies or if they differ significantly from other analysts. The
investors have their own internal team of buy side analysts who validate those outputs and
carry out further analysis. The sell side analysts often follow-up on their reports and outputs
with detailed calls with investors explaining their rationale and also set up calls with
company management for the investors for further discussions.
The sell side analyst outputs are also used a tool to evaluate and engage with the sell side
analysts. This is important as an investor typically engages with only top 5–10 sell side
analysts. However, engagement does not depend only on performance of sell side company
recommendations and forecast error. As the buy side analysts deliberate and carry out their
own independent assessment, the sound basis of the sell side investment rationale along
with other services provided like management access also help to decide further
engagement, even though profitable recommendations are important too.
An important distinction that came out in our interviews were the seemingly different
roles played by the buy side analysts compared to the sell side. Even though, both carry out
company analysis, the sell side forecasts and recommendations could be biased due to
various conflicts of interests, while the buy side analysts without any conflicts are better
placed to provide their own unbiased views. The buy side analysts are also under more
pressure for their investment decisions to perform well, even though sell side analysts are
judged on variety of other parameters. This is particularly true for mutual funds which for
whom NAV performance, even in the short term, is more critical. The buy side analysts play
the role of validating the sell side outputs, have meetings with the management and carry
out their own independent analysis for the investment decisions. However, the scope of the
Role of sell
side analyst
outputs
QRFM
buy side analysts is broader, and they cover more companies compared to sell side analysts
who are more like sector specialists (Groysberg et al., 2007).
Finally, we try to rank different attributes of a sell side analyst and the types of service
they provide, which provided maximum value addition to institutional investors. We find
that the industry knowledge of the analysts is the most desirable attribute, followed by
accessibility and responsiveness to enable decision-making. Surprisingly, compatibility
with buy side analysts also plays an important role, which highlights the “human” element
of these interactions. External analyst rankings and pedigree are not that important to
investors (Brown et al., 2016).
In types of service desired by investors, the access to company management provided by
the sell side analysts is the most desirable. Surprisingly, markets and trade information,
apparently non-fundamental factors, are also valued highly, particularly by mutual funds,
which might be a reflection of the industry competitiveness. The analyst reports and
financial models are also useful but lesser than the earlier two factors. Also, more
importantly, the analyst forecast accuracy, which is one of the most prolific topics in
literature on sell side analysts, do not seem to matter too much to investors! This means that
researchers have been spending a lot of time on topics, which do not play a very important
role for investors, while ignoring some of the more important ones.
The implications of our work are for companies, sell side analysts, regulators and
researchers to understand how institutional investors make their investment decisions and
the role of various sell-side outputs in the same. Our study sheds light on the entire
investment process as opposed to just the sell side analyst forecast, which is only one of the
inputs to the process and as we found, not the most important one. A deeper understanding
of the investment process is more useful for regulators, especially in an emerging markets
context, to devise policies to enable greater transparency and compliance. Sell-side analysts
can also use our work to understand that are the most important activities and attributes
useful for institutional investors and improve their services by incorporating the same.
7. Conclusion and implications
Academic research on institutional investors have generally been sparse in extant literature,
raising a valid question on their decision-making processes. It is also important to further
explore the role of sell side analysts in this process given the preponderance of literature on
their forecasts and its empirical properties, but hardly any on the importance of their
outputs to their primary clients, that is, the institutional investors. This assumes further
importance for emerging markets such as India where information asymmetry and weak
governance structures call for a concerted understanding of the same. In effect, till now no
study has examined these issues in the contextual setting of emerging market of India. The
qualitative orientation of this study as opposed to quantitative orientation in extant
literature provides significant insights into what goes behind-the-scenes in terms of
investment practices and how sell side analyst outputs are used in the process. Our
extensive field study conducts face-to-face semi-structured interviews with senior leaders
from institutional investing firms (primarily Mutual Funds, Insurance Companies, wealth
managers and family offices) to penetrate the black box of investment decision-making by
identifying and conceptualizing the role of sell side analyst outputs to stock investments.
Our interviews touched upon the important role of sell side analysts in institutional
investors’ investment decisions. We explored how sell side analyst outputs are used to take
investment decisions and mapped the process of engagement of sell side analysts by the
investors. We also contrasted the role of internal buy side analysts who provide more
unbiased independent analysis compared to those of the sell side. The study further reports
sell side analysts’ industry knowledge and access to company senior management as
defining criteria in fund managers’ decisions. Finally, in contrast to extant literature, past
forecast accuracy and analyst pedigree were rated lower in the pecking order in terms of
usefulness in investment decision-making process of fund managers.
Going forward, while this extensive field study identifies significant aspects of
investment decision-making process of institutional investors in emerging markets, it also
raises an intriguing paradox that the most researched topics like forecast accuracy are not
that relevant for actual practitioners while more important criteria do not have too much
research coverage.
Our study provides strong outputs to sell side analysts in terms of their roles and
working relationship with fund managers. Sell side analysts play a central role in shaping
up the decision-making of institutional investors, and this study can go on a long way in
improving service levels as well as nature of their interactions.
Our study also has profound implications for various stakeholders such as companies,
sell side analysts, policy makers, researchers and students of finance in terms of detailed
understanding of investment processes. Such work would be useful for regulators,
especially in the context of emerging markets, to get a deeper understanding of investment
processes to frame better policy for transparency and compliance. Sell-side analysts can also
use our work to focus on the activities and attributes useful to institutional investors so that
they can improve their service levels.
Notes
1. Although the primary focus of our study was Indian equities, in some cases interviewees were
also responsible for managing hybrid or balanced funds having other asset classes. www.pwc.
com/ng/en/press-room/global-assets-under-management-set-to-rise.html
2. In an Indian setting, fund managers are responsible for managing and performance of
the designated portfolios. Buy side analysts have a primary responsibility of multiple sectors and
are responsible for issuing buy/sell recommendation of company in assigned sectors. www.
amfiindia.com/indian-mutual
3. Scheduling of interviews was a complex exercise on account of timing availability and workrelated travel of interviewees. However, we have been able to complete all interviews planned on
time. Fund “alpha” is defined in industry as the outperformance against a declared benchmark.
4. The interview guide containing broad themes was followed in each and every interview with the
respondents. NAV = net asset value of the fund.
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Corresponding author
Arit Chaudhury can be contacted at: achaudhury@imt.edu
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