Window Dressing - the Art of Looking Smart
As investors we need to better understand the idiosyncrasies of the stock market to stay informed and most importantly, to assist with our decision-making process. At least four times per year, price movements become more of a function of institutional type trading practices than they reflect economic or fundamental forces. Toward the end of every calendar quarter, the press, and media report on the impending window-dressing activities. What does it mean to you as an investor?
Many investors continue to question the usefulness of money managers engaging in window dressing activities toward the end of each quarter. Window dressing is neither an investing strategy nor is it speculating. Rather it is more of a cosmetic or a marketing strategy to paint a better picture or a better perception of a fund. In other words, to make the fund manager look smart.
However, in reality, if you had a terrible quarter and you buy the best-performing sectors or stocks for that quarter and in turn, you sell the worst performing sectors or stocks into the quarter, you still had a bad quarter. An investor who owns the underperforming fund he or she would still be unhappy with the fund manager even if the portfolio has been cosmetically dressed up with the best-performing stocks at the end of the quarter.
If the outperforming stocks continue to do well, the manager may pick up returns and will, therefore, look smart to their clients. However, if the outperformers fail to keep up with the market, it will become apparent the manager was window dressing the portfolio. Several academic studies have shown that portfolio adjustments toward the end of the quarter were the greatest among the worst-performing funds. On the other hand, window dressing practices offer the greatest benefits for the middle-performance funds.
Nonetheless, with less than a week before the end of the second quarter, we can expect many money managers to again participate in their quarterly ritual of marking-up and marking-down their books. The collective actions of the money managers create artificial demand for many of the outperforming sectors and stocks and unwarranted weakness in poor performing sectors and stocks into the end of the quarter. So, the window dressing activities are more of an art of making fund managers look smart.
Enclosed are the first half of the year and the second quarter-to-date performances of the 11 major S&P 500 Sectors as well as the S&P 500 stocks.