When sell-side stock analysts tell the public to buy, they may in fact be whispering sell to their institutional investor clients, according to a new working paper by Yushui Shi, a PhD candidate at the University of California, Irvine.

The paper, which is based on data from China, looks at mutual fund managers voting for analysts in a ‘star analyst’ competition. The researchers found a positive relationship between analyst saying buy and then managers deciding to sell, but still voting for the analyst.

To reach this conclusion, the research looked at the voting data, as well as analysts’ real recommendations and managers’ real investment decisions. “The way we measure the analysts’ ‘say-buy-while-whisper-sell’ behaviour is we measure the percentage of the managers trading stocks that are at the same time recommended as buying by analysts.”

The research did this for any manager-analyst pair. “At first glance, it just seems a little bit odd, but then we realize it may be something underlying this information change,” Shi says. “It’s like analysts know more information — more precise information — so even though the analysts tell the public to buy the stocks, the analysts still can have very precise information that is different than what they say in the public. And if the analysts do tell such precise information to the managers, managers can sell the stocks.”

As an example, if an analyst tells the public there’s good news about a firm, there’s still uncertainty because the public won’t know how good the news is, says Shi. “Whether it is good or really good, it just says: it’s buy. So you can see . . . retail investors in the markets, they cannot distinguish whether this is good or really good.”

As a result, the public may think the price should sit somewhere between good and very good. However, if the analyst tells the manager the true information of whether it’s good or really good, they’ll know whether it’s currently overpriced or underpriced.

Saying buy to the public, but whispering sell to managers can be beneficial for analysts, he says. This is because compensation for analysts in China is commonly based on bonuses, so if they recommend something to institutional investors, the investors accept the recommendation and then the brokerage firm executes the trade, the firm and analyst are compensated accordingly.

As well, analysts want to become ‘star analysts’ because it’s good for their career. Therefore, they can provide information in the hope of attracting votes. “Say I give you superior information, in return you vote for me,” says Shi. “And you make me a star and I will benefit from that.”

This doesn’t mean analysts are being unlawful or evil, he cautions. “I think it’s just the basic things [people are] doing in the industry based on incentive construct.”

The paper was presented by Shi at the Northern Finance Association Conference in September 2019 in Vancouver.

UPDATED OCTOBER 6 at 9:18 p.m.