We usually read it in the news:
Shares are expected to open higher today, supported by fund managers window dressing their portfolio before the quarter ends.
What is window dressing?
Window dressing is arguably a deceptive strategy employed by fund managers in which they try to make their portfolio look as attractive as possible before presenting it to clients or stockholders.
The rationale behind it is to make the portfolio appear in good form. Performance reports and a list of the holdings of the fund are usually reported to investors every quarter. In the days leading up to the end of the quarter, fund managers would sell stocks with large losses or purchase recent winners. Doing so makes it appear like they own the best-performing stocks of the quarter.
Let’s see three examples of window dressing in action.
Examples of Window Dressing
Example 1. Suppose at the start of the quarter, a fund manager bought stocks of XXX CORPORATION at P5.00 per share in the hopes that its price will increase.
During the last week of the quarter, however, XXX stock has fallen to P1.90 per share, a 62% drop in value. Afraid that a losing stock would show up in his end-of-quarter portfolio report, a fund manager would choose to sell this stock despite a heavy loss. Of course, the sale would realize the loss, reducing the fund’s value.
Example 2. Similarly, a fund manager could window dress the portfolio by buying best-performing stocks. A manager could buy shares of a stock that has rapidly risen during the quarter. The fund manager missed the stock prior to its price increase, but a few days before the end of the quarter, the manager would purchase this stock. Why? So that the portfolio would look like it contains a stock that has been profitable.
The problem? Although the stock is now part of the holdings, the portfolio reaped no benefit because the stock has already rallied prior to the purchase. If the price of this stock even fell at start of the succeeding quarter, this could produce a loss for the portfolio.
Example 3. There are also cases where fund manager try to push up prices of the stocks they own by buying more of the same stock or by trading (buying and selling) the same stock in just a few hours or days. The effect would be an increase in price since fund managers would buy the stock several times at higher prices. They also hope that the volume would be noticed by other players who would soon join the price bidding, further surging the stock price.
The problem is that prices may be artificially inflated and, by the next quarter, the stock’s price could fall below the stock’s acquisition cost, leading to a loss that could impact the portfolio value. The fund could also be spending a lot of transaction costs due to the high number of trades, and these costs will be treated as expenses charged against the fund.
Window dressing per se is not illegal but may cause adverse consequences to a portfolio if used improperly. As knowledgeable investors, you should look at your fund’s holdings of stocks and monitor if they were bought as part of a wise trading strategy by a competent portfolio manager or merely a window dressing strategy of a cunning fund manager.
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Thank you for this wonderful and very comprehensive guide! Makes it so easy for us to learn more about stocks.