WSJ: What Is Window Dressing?

By SIMON CONSTABLE

To most people the holiday season means decorations at home and at work, but it also
can mean “window dressing” in your mutual fund.

This somewhat disparaging term is used to describe the practice of a mutual fund
making cosmetic changes to its portfolio just before the end of each calendar quarter.
It’s done because funds publish their exact holdings of securities four times a year
based on what they own at the end of each quarter.

“The basic concept is that managers are either hiding their mistakes or adding winners
to make themselves look a little smarter,” says Russ Kinnel, director of manager
research at fund researcher Morningstar Inc. in Chicago. “Of course, it doesn’t
necessarily help performance,” he adds.

While most investors focus on a fund’s performance more than its portfolio, many
investors do pay close attention to funds’ holdings—and they don’t want to see a fund
holding on to a disastrous investment or missing out on a major upward move by a
stock. Window dressing helps those investors look more favorably upon the fund
manager, Mr. Kinnel says.

Market observers have long suggested that window dressing leads to more stock
volatility around the ends of quarters, and a recent study by the Wisconsin School of
Business seems to confirm that is a real phenomenon.

“The stocks that rank high on intermediate-term momentum and that are purchased at
the end of a quarter experience large positive returns at that time, followed by large
negative returns in the next month,” says the report, written by David P. Brown, a
professor in the school’s department of finance, investment and banking. Or put another way, a highflying stock may fly even higher near the end of a quarter and
then come back to earth the next month

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