A new study released this week found that retail investors are more likely to trade or own stocks that are covered by brokers who also have financial advisors working in the investors’ metropolitan area, even if those investors aren’t clients of the brokerage.
The study, carried out by Daniel Bradley and Jared Williams, two professors at University of South Florida, along with William Gerken, professor at University of Kentucky, looked specifically at the geography of client-facing financial advisors in relation to analysts who worked at the same firm.
“Most brokers maintain a research division that employs sell-side analysts who cover and provide research on stocks. This research gets disseminated to numerous in-house financial advisors, who then pitch these recommendations to their retail client base,” the study stated. “[But] the information flow does not necessarily stop here; it is likely that the broker’s clients share the information with their friends, neighbors, and coworkers.”
Examining almost 750,000 transactions, the study found a “strong and robust” relationship among analyst coverage, financial advisors and retail ownership, which alone was not all that surprising, the study said. Of far greater interest was the reason why.
There were two potential reasons why coverage might lead to an increase in the buying or selling of a certain stock at a certain time. “One possibility is that these results are driven by investor awareness: specifically, the retail investors who have accounts with the large discount brokerage might learn about a stock from their friends, neighbors, and coworkers, who learned about the stock from their financial advisor at their full-service brokerage. We call this the investor awareness explanation,” the study said. “An alternative possibility is that retail investors blindly follow the advice of brokerages, and when brokerages recommend that investors buy a stock, they buy it, and when they recommend that investors sell a stock, they sell it. We call this the investor credulity explanation.”
Between the two explanations, investor awareness was far stronger, the study said. “First, there is only a weak association between the level of optimism of the brokerages that are concentrated in an area and the retail ownership and trading activity of the stock. Second (and relatedly), high concentrations of financial advisors who work for brokerages that cover a stock are associated with high levels of ownership and trading activity (including buying volume), even if the brokerage is pessimistic about the stock. Thus, we conclude that investor awareness better explains our findings.”