Fund managers are paid bonuses based on performance and some for attracting investors to buy their funds. Hedge funds are notorious for high bonus structures on performance. It is important to know the games that fund managers play at the end of every quarter.
It is a strategy to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high-flying stocks near the end of the quarter. These securities are then reported as part of the fund’s holdings.
Another variation of window dressing is investing in stocks that don’t meet the style of the mutual fund. For example, a value fund manager might invest in stocks that are in a hot sector at the time, disguising the fund’s holdings, so clients really have no idea what they are paying for.
The Dec 31 yearend quarter is by far the most important quarter because they want to attract investors that don’t contribute money into their retirement accounts until the first part of the new year.
A portfolio manager practicing closet indexing picks stocks in terms of weighting, industry sector or geography that are very similar to an index that they are supposed to beat. A manager’s performance is usually compared to his or her benchmark index, so there is an incentive for managers to gain returns that are at least similar to the index.
Do Your Homework
- Check the quarterly 10 ten listings and compare.
- Does the performance of the fund consistently beat the benchmark index?
- Does the mutual fund have a high stock turnover rate?
- Is the current fund manager responsible for the long-term past performance numbers?
- Was the manager performance based on skill or just luck because of an over exuberant bull market?
Window dressing and closet indexing may make a fund appear more attractive, but they can’t hide poor performance for long.