Window Dressing

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What is 'Window Dressing'

Window dressing is a strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of a fund’s performance before presenting it to clients or shareholders. To window dress, the fund manager sells stocks with large losses and purchases high-flying stocks near the end of the quarter. These securities are then reported as part of the fund's holdings.

BREAKING DOWN 'Window Dressing'

Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter and clients use these reports to monitor the fund's investment returns. When performance has been lagging, mutual fund managers may use window dressing to sell stocks that have reported substantial losses, replacing them with stocks expected to produce short-term gains to improve the overall performance for the fund for the reporting period.

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 in a hot sector at the time, disguising the fund's holdings, and investing outside of the scope of the fund’s investment strategy.

Monitor Your Fund Performance

For investors, window dressing provides another good reason to monitor your fund performance reports closely. Some fund managers might try to improve returns through window dressing, which means investors should be cautious of holdings that seem out of line with the fund’s overall strategy. The act of window dressing is under close watch by investment researchers and regulators with potentially forthcoming rules that could require more immediate and greater transparency of holdings at the end of a reporting period.

While window dressing overall can prove to help a fund’s returns in the short-term, longer-term effects on a portfolio are typically negative. Thus investors should pay close attention to holdings that appear outside of a fund’s strategy. While these holdings may show higher short-term performance, over the long-run these types of investments will drag on the portfolio’s returns and a portfolio manager can’t often hide poor performance for long. Investors will certainly identify these types of investments and the result is often lower confidence in the fund manager and increased fund outflows.

Window dressing also occurs across various other industries to improve a business’s return. Companies can offer products at discounted prices or promote special deals that will enhance sales for the end of the period. These promotional efforts seek to increase a business’s return in the final days of a reporting period.

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