Investors simply emulating the masses and failing to think independently constitutes a well-known blunder. Less well known and in a sense more alarming, is the fact that analysts do it too. Given that both institutional and private investors rely on these people to guide them and their money in the right direction, it is disconcerting to know that they also often go with the herd rather than with the head.

Herding Behavior and Analysts
The investment literature demonstrates quite clearly that analysts tend to converge toward the "prevailing consensus forecast." In plain English, they are inclined to avoid sticking their necks out too far, and more or less recommending the same investments as their colleagues. They probably don't get carried away with greed and panic the way some private investors do, but all the same, going with the flow is not what analysts are there for. At worst, one could argue that one simply does not need analysts unless they do their own homework and form their own opinions.


Forecasts that diverge from those of colleagues are generally referred to as "bold," whereas those that go with the flow are indeed termed "herding forecasts." While excessive boldness can obviously be dangerous for investors and the analysts themselves, excessive herding tendencies surely make the analysis a bit pointless. After all, if analysts become part of a speculative bubble, they lose their objectivity and independence.

What Leads to Bold or Herding Forecasts?
Analysts who are more confident in their information sources, and presumably in their own abilities, tend to be bolder. Therefore, experience should raise the level of boldness and general, rather than firm-specific experience, seems to help as well. Working for larger brokerage houses evidently increases boldness and so does giving forecasts that are not extremely complex. Having an established reputation as an analyst also allays fears of going out on a limb and away from the crowd.


Conversely, herding is likelier with inexperienced analysts who lack confidence, work for smaller houses and do complex work. They will be wary of "deviating from the mean." Leader-follower effects may also prevail, such that one or more analysts become regarded as gurus and lesser "mortals" tend to follow them blindly and timidly.

"Career concerns" are another important and related factor. Clement and Tse (2005) warn that for this reason, analysts "seek safety in forecasts that are close to the consensus." This implies that boldness may jeopardize analysts' career chances, a dangerously ironic situation. The irony is that, not surprisingly, there is evidence of boldness increasing forecast accuracy. After all, boldness reflects private information (not available to all), original thinking and a willingness to be anti-cyclical. So analysts really should be bold to maximize their effectiveness.

Various other factors can lead to herding. Interestingly, just before the big 2000 crash, John Graham drew attention to some of them. For example, it may be that many analysts receive the same information, which would inevitably lead to herding. That is, it is not clear exactly how much private information is really available and how much it is used. Analysts may also investigate companies the same way, which is really a kind of "investigative" herding rather than behavioral.

What Does This Imply About Analysts?
Firstly, investors really need to know if they are using or being influenced by bold or herding forecasts. This is fundamental, as the two are completely different in approach and value. Reading analyst reports carefully and comparing them with others, should make it possible to figure out which one you are dealing with; but of course this is a time-consuming nuisance and should not be necessary.


Secondly, there is the issue of cost and value. Are herding forecasts of any real value? This is debatable, and they are surely not worth paying much (if anything) for. The views of the masses are, after all, out there in the mass media.

Thirdly, watch out for hidden herding analysts. If you have an actively-managed fund or portfolio with a broker or bank, they may be influenced by such analysts. Is this what you really want? You certainly have a right to know, one way or the other.

Fourthly, analysts themselves should consider their real roles and duties. They should bear in mind that if they are bold and get it right, they will surely be rewarded over time. If they are wrong for legitimate reasons, such as an act of God or an unpredictable market change, they, their employers and their clients should be able to live with this.

How to Prevent Analyst Herding
Given the factors described above, a degree of analyst herding seems inevitable. If both private and institutional investors make it quite clear that they want original and free thinking, however, this might encourage bolder forecasts. Likewise, employers of analysts must ensure that such forecasts are duly rewarded and that there is no censure for rational and well-researched views, even if they ultimately prove wrong. In career terms, being bold needs to pay off for the analysts themselves, and getting ahead must not be fostered by conservative and consensus-driven mediocrity.


The Bottom Line
The reality of analyst services is that they are subject to herding in a similar, but not identical, manner to private investors. This is not good news, because herding implies suspending original thinking and playing it safe, which surely runs counter to the whole point of analysts. The consensus opinion may be of some use, but one definitely needs to know whether or not this is what one is getting. Bold is not necessarily better, but a lot of the time it surely will be. The industry itself needs to encourage boldness and make it more of a career winner.




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