What is Window Dressing in trading?

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Author: Sarthak Bhalerao

Table of Contents

  1. What is Window Dressing?
  2. How does Window Dressing work?
  3. Window Dressing and Mutual Funds
  4. Example of Window Dressing
  5. Conclusion

What is Window Dressing?

The term ‘Window Dressing’ is commonly used to refer to the way how a retail business presents its goods to look most appealing to a pedestrian walking past its window. However, in finance terms, it means slightly different. In finance terms, Window Dressing is a strategy used by many portfolio managers and mutual funds to improve the appearance of their fund’s performance before presenting it to a client or shareholder. To window dress, one sells stocks with larger losses and purchases stocks having great returns near the end of the quarter or year. Window dressing also refers to the efforts taken by a company or organization to make their financial statements more appealing before they are released to the public. This can be achieved by postponing payments or finding a way to book early revenues.

How does Window Dressing work?

Whenever a manager is looking to boost its investment performance prior to shareholder or client presentation, they tend to turn towards window dressing. Performance reports and holdings in a mutual fund are usually sent to clients every quarter so that the clients can monitor the investment returns. Mutual fund managers use window dressing whenever their fund is lagging. They sell stocks with higher losses and replace them with stocks that are expected to give good returns in short term. This helps the fund increase its performance and is more presentable to the shareholder and clients.

Window Dressing and Mutual Funds

Window dressing is performed heavily with mutual funds. During the end of any reporting period, mutual funds often quickly sell non-performing stocks from their portfolio. This money is then utilized to buy shares of the companies that are high performing or have great potential to give short term gains. This rebalancing of the fund is designed to make the fund’s appearance better. By using window dressing, the fund managers make the fund more promising. This attracts potential investors as they can see that the fund consists of high performing stocks, and they overlook the fact that poor-performing stocks were dumped recently. As a result, these investors are more likely to invest in these funds. This helps the fund gain more investors and consequently, more money gets added to the investment pool.

Example of Window Dressing

Let’s assume that a fund investing in the stocks from the S&P 500 has underperformed the index. That fund has 4 stocks: A, B, C, and D. Stocks A and B outperformed, but were underweight in the fund, while 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 the stocks C and D and replaces them with A and B. This gives an overweight to the stocks A and B.

Conclusion

Window dressing is a short-term strategy used by many different companies and funds to make sure that their financial reports and portfolios look more appealing to clients, consumers, investors, and shareholders. The goal is to attract more people and more money, hopefully boosting the next reporting period’s bottom line.

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Sarthak Bhalerao

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