Window Dressing

Window dressing is a strategy used by mutual fund and other 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.

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 of the fund for the reporting period.

Another variation of window dressing is investing in stocks that do not 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 the scope of the fund’s investment strategy.

EX:
A fund investing in stocks exclusively from the S&P 500 has underperformed the index. Stocks A and B have outperformed the total index but were underweight in the fund. Stocks C and D were overweight in the fund but lagged the index. To make it look like the fund was investing in stocks A and B all along, the portfolio manager sells out of stocks C and D, replacing them with, and giving an overweight, to stocks A and B.

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