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Should you follow broker research to buy ASX shares?

A lot of retail investors like to follow broker calls in making their investing decisions. Recently though the worth of positive and negative ‘broker research’ has been called into question as businesses like WiseTech Global Ltd (ASX: WTC) and Rural Funds Group (ASX: RFF) face short seller attacks.

What is sell side research?

Sell side broker research is normally ‘positive’ as brokers want clients to trade. It commonly includes psychological tricks such as ’12 month price targets” also largely designed to encourage retail trade. 

Typically a mid-sized advice and brokerage operation in Sydney or Brisbane will have advisers tell their clients to put $10,000 into a small-cap stock such as Volpara Healthcare Technologies Ltd (ASX: VHT) for example.

The broker will earn a small fee on the trade in addition to the advice fee. 

The kicker is once a lot of the brokers’ clients are in the stock it might release positive research on the business and a bullish ‘price target’ that bumps up the share price. This is a small win for the broker and its clients.

Brokers are pretty smart and will use every legal advantage possible to boost returns. 

This trick is similar to how short sellers in WiseTech build their short positions prior to releasing short reports for maximum publicity. It wouldn’t make sense to build them after the price had fallen.

As we can see the potential losers in all this are retail investors following the advice after it’s publicised.

This is not always the case, but blindly following broker research notes can increase your chances of ‘buying high’ and ‘selling low’.

You don’t get something for nothing in life. Especially not in the share market. Therefore any research that appears ‘free’ probably isn’t worth acting on.

How does buy-side work?

Buy-side asset managers won’t generally release research as they have nothing associated to sell.

The research and stock picks are their IP and it wouldn’t make sense to release it publicly. At asset managers ‘recommended research lists’ are guarded with only certain market-facing staff given digital permissions to access. 

Traditionally sell side brokers have provided their research to buy-side fundies as a form of soft commission. Outwardly this is as a favour similar to providing sports tickets or the like.

However, the practice has long been in the sights of regulators due to the perception fund managers may be unduly influenced to pay the most brokerage commissions to brokers who provide the best hospitality.

This would be a conflict and breach of regulations as buy-side managers are obliged to seek ‘best execution’ for their underlying clients. 

Foolish takeaway

In general many sell-side broker calls tend to be on the money. So it’s always worth taking a look at what this community is tipping as good buys. Consensus broker calls currently tip Bapcor (ASX: BAP), NextDc (ASX: NXT) and Aristocrat (ASX: ALL) as strong buys. In another article I’ll take a brief look at these businesses. 

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Tom Richardson owns shares of Bapcor, Dicker Data and WiseTech Global.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of VOLPARA FPO NZ and WiseTech Global. The Motley Fool Australia owns shares of and has recommended Bapcor and Rural Funds. The Motley Fool Australia has recommended VOLPARA FPO NZ. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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