Tue 26 Sep 2006
It seems like quite a few people are claiming the rally on Monday and Tuesday this week is simply just mutual fund (or even pension fund) window dressing. It got me thinking about what it really consists of and whether or not it happens.? Here’s Investopedia’s take on window-dressing:
A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders.
Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter. To window dress, the fund manager will sell stocks with large losses and purchase high flying stocks near the end of the quarter. These securities are then reported as part of the fund’s holdings.
Another variation of window dressing is investing in stocks that don’t meet the style of the mutual fund. For example, a precious metals fund might invest in stocks that are in a hot sector at the time, disguising the fund’s holdings, so clients really have no idea what they are paying for.
So, is it possible? Yes, it is not only possible, but frequently occurs.? Check out Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds.? One interesting point they make is that the window dressing is noticable at quarter-end but not month-end:
Magnitudes range from around 50 basis points per year for large-cap funds to well over 200 basis points for small-cap funds. There is little or no effect at month-ends that are not quarter-ends.
…it is potentially serious because month-ends are common investment dates
in automated investment plans.Paycheck transfers could in principle contribute to the inflation if they are redirected to recent winners, but this would presumably be symmetric across month-ends […], not concentrated at quarter-ends.
The analysis was done with data up to 2000, so the behavior could have changed since then.
Unfortunately, I don’t think the behavior is consistent enough to trade off-of, but if you’re planning on selling something near a quarter’s end, you may want to consider if it is a stock that would benefit from quarter-end window dressing…
September 27th, 2006 at 7:53 am
I was going to post a warning that Sept was the end of the fiscal year for most mutual funds, making this week a crazy game of end-of-year shuffling. While I don’t know yet how to trade to take advantage of this phenomenon, I do know that whatever happens in the market this week should be taken with a grain of salt and not projected forward.
September 27th, 2006 at 8:07 am
After a little though, here’s two opinions on stocks “that would benefit from quarter-end window dressing”:
–Any stock that’s performed in the top 10% of the market that’s within the mutual fund’s cap or Value/Growth range. Since Mutual Funds don’t disclose when they purchased a particular security, it looks good on their publications and listing of “top 15 holdings” to show that they were on the right track. I would expect that this would have a positive, but short-term, effect on these securities.
–Any stock that’s been getting a lot of press lately. Since the end-of-year and end-of-quarter snapshots of mutual fund performance also involve a list of top security holdings, I suspect that mutual funds would want to add a “Google” to their list or something widely known for a few good reasons: (1) helps the common investor identify with their holdings and feel like they “understand” the mutual fund’s position, (2) helps keep their more interesting and potentially long-shot plays out of publication to be scooped by competitors (assuming they are still in a buy-up period), and (3) helps show that they are up on the latest information and keeping abreast of the trends. I personally think most mutual funds are just marketing vehicles with most of the energy pumped into them focus on making them look good to new investors and not scare away current investors, rather than focus on making exquisite market decisions.
September 27th, 2006 at 9:43 am
I recently read an article at Contrahour about how Fidelity was the number one or number two holder of just about every large and mid cap energy stock before the recent drop in the energy sector. Some believe that what is fueling the market recently is a massive sector rotation at Fidelity. They are selling off the profits from energy and buying more defensive stocks. What might happen when this wears out? It’s not necessarily window dressing per se, but it does point to the potential power of large mutual funds in the markets.