It is the end of the quarter this Friday and one keeps reading and hearing about one possible additional reason for market moves this week, aside from European news, is the quarter-end phenomena of “window dressing.”
Having been around the financial markets for quite some time, I honestly can say I have never fully grasped the concept.
Sure, back in the era before computers, instant access to data, and the Internet, it is somewhat understandable that portfolio managers could “fool” anyone looking at their holdings by making quarter-ending changes that might go unnoticed in terms of their timing.
But in this day and age, why is the term still thrown around so often?
According to Investopedia:
“Window dressing is a strategy used by mutual fund and portfolio managers near the year or quarter end 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.
Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter. Another variation of window dressing is investing in stocks that don't meet the style of the mutual fund. For example, a precious metals fund 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. Window dressing may make a fund appear more attractive, but you can't hide poor performance for long.”
Ok, that really didn’t tell me anything I did not already know. Let’s try and dig a bit deeper.
The tactic is old as the hills; the Pecora Commission, which investigated the 1929 crash, found that banks and investment firms scrubbed their lists of holdings on the last day of the reporting period "to present a financial statement of sound appearance."
But beyond that little tidbit there is not much out there on window dressing that we haven’t briefly explained above.
Now, what I really think is happening is a gross misusage by the business press of the term “window dressing”, often confusing it with end of the quarter “portfolio rebalancing”.
This is actually a legitimate exercise in which portfolio managers might reassess winners and losers in equities, change the relative weightings of various sectors, shift the allocation of funds between major asset classes, including cash, and any number of other strategic moves.
What is more interesting about “window dressing” is the use of the term in the context of the 2008-2009 financial crisis and its fallout ever since. The term is now being used also in the broad context of major financial institutions trying to hide exposure to riskier assets and their levels of debt.
The SEC has for years been concerned this potential Wall Street tactic, as banks find ways to shed debt before reporting finances to the public. Since the financial crisis, window dressing has increased, according to a Wall Street Journal analysis, as banks have grown more sensitive about showing high levels of debt and risk.
Though window dressing isn't illegal (according to some analysts), intentionally masking debt to deceive investors violates regulatory guidelines. Bank of America, Citigroup, Bank of NY Mellon, Lehman and others have all said they mistakenly booked some “repo trades” as sales when they should have been borrowings, but said the amounts were immaterial. “Repo trades or repo purchases” refers to selling riskier investments prior to earnings reports only to repurchase the investment following the company’s report.
Give me a break.
If a bank cannot make money these days borrowing funds at essentially zero interest rates and lending it out at rates anywhere from 4-22%, and then still has to “window dress” the books, it is hard to even comment.
Good Trading!
David W. (aka The Underground Trader)
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