Cherry Picking

What Is Cherry Picking?

Cherry picking is the process of choosing investments and trades by following other investors and institutions that are considered reliable and successful over the long term. 

Cherry picking is done by both professional and retail investors alike. Typically, cherry picking doesn't involve research but instead, involves using the research of other reliable sources. Although the process of cherry picking can lead to choosing top securities, it can also lead to investors overlooking the broader market metrics.

Cherry picking can also be referred to as the fraudulent practice of allocating profitable or unprofitable trades by investment managers and their staff to certain accounts preferentially.

How Cherry Picking Works

Cherry picking can be an effective way to generate returns and is often used by both individual investors and fund managers. Cherry picking can be helpful for investors who are unfamiliar with the process of stock selection and investment research. These novice investors can choose to invest in the top securities of a particular mutual fund or portfolio. A mutual fund is a basket of securities or stocks purchased by pooled funds and actively managed by a fund manager. However, cherry picking is not considered to be a best practice for comprehensive analysis and investment decisions.

Individual Investors

Individual investors may find success in following top-performing fund managers or mutual funds and choosing to invest in the best-performing stocks from their portfolios. Cherry picking can be a quick way to identify stocks for investment. Since it does not require deep analysis or research from a broad universe, it can reduce the amount of time required for identifying investments.

For example, an individual investor may be interested in stocks from the semiconductor market category. Rather than having to research all the stocks that deal with semiconductors within the exchanges, an investor may instead look at a few mutual funds investing exclusively in the semiconductor category. From there, they may choose to further investigate and invest in some of the best performing securities.

Fund Managers

Fund managers are typically required to do intensive research when choosing investments for actively-managed funds. Security investment in the portfolio is typically dictated by the fund’s investment strategy, which is outlined in its marketing materials and prospectus.

In some cases, fund managers may cherry pick top investments from sources they deem to be reliable. Adding these chosen securities to the portfolio is typically outside of the standard procedure for their investment strategy. Some fund managers may integrate investments and proprietary investment research across different funds from the same investment company. While intended to be a collaborative investment approach, this type of strategy can generally be viewed as cherry picking.

Cherry Picking and Fraud

Another version of cherry picking involves the fraudulent practice of allocating winning trades to an adviser's personal account or to favored clients–a process banned by the U.S. Securities and Exchange Commission (SEC). The SEC is responsible for maintaining a fair and orderly functioning securities markets.

Typically, investment managers initiate block orders in the market to buy or sell for all of their customer accounts simultaneously. Block orders or aggregated orders are processed electronically through order management systems. Those trades can have either gains or losses associated with them. 

The fraudulent act of cherry picking involves investment managers selecting specific profitable or unprofitable trades and allocating them in a manner of their choosing. For example, the investment manager might allocate the profitable trades to their own personal account or to certain clients in order to give them preferential treatment.

Conversely, the losing trades might be allocated to other accounts of the investment manager's choosing. Any trades that were allocated to the investment manager's personal account or the employees of the firm would be done at the expense of the clients of the investment management firm.