The literature surrounding the relation between the trading of mutual funds and the recommendations of sell-side equity analysts is characterised by a lack of definitive, large-sample empirical evidence. This thesis meets the pressing need to undertake such a study in order to understand the behaviour of these important capital market participants.
My study makes five significant contributions to the literature. First, I use individual mutual fund holdings and detailed analyst recommendations to test whether the recommendation changes of individual analysts help to explain the trading of mutual funds at the individual fund level. In contrast, prior studies limit their analysis to aggregate changes in institutional ownership and consensus recommendations. Accordingly, this thesis represents by far the most comprehensive study of the relation between mutual fund trading and analyst recommendations undertaken to date. Second, my study is the first of its kind to include the prior quarter recommendation change as an independent variable in the regression analysis. It thus delivers more definitive inferences about the direction of causality in the relation between mutual fund trading and analyst recommendations than prior studies which only consider a contemporaneous relation. Third, I find strong evidence that mutual funds trade in a manner consistent with the recommendation changes of sell-side analysts. This finding contradicts the repeated claims of fund managers that they assign little weight to analyst recommendations when making portfolio decisions. Hence, this study underscores the importance of undertaking large-sample empirical analysis to understand investor behaviour. Fourth, I find evidence that the most influential analysts exhibit persistence in their influence on the trading of mutual funds. Finally, my resl1lts reveal that analysts rated most highly by fund managers in the Institutional Investor surveys exert significantly more influence on the trading of mutual funds than their peers.