On the last day of the quarter, look out for window dressing and marking up.
June 30, 2003: 8:16 AM EDT
By Justin Lahart, CNN/Money Senior Writer
NEW YORK (CNN/Money) - The stock market is cued up for its best quarterly performance since 1998, but not everybody is pumping their fists.
Wringing their hands is more like it for all the mutual fund managers who haven't participated in the rally. It is perhaps forgivable if they haven't beaten the S&P 500's 15.1 percent move -- there's a long tradition of underperforming the benchmark -- but if their returns have lagged below their peers', that is a different story.
But underperforming funds have tools, which they will never admit to using, at their disposal to help soften the sting. Welcome to the wonderful world of window dressing and marking up.
Window dressing -- the scuttling of poorly performing stocks and the buying up of gainers -- doesn't do a thing to improve returns, but it does gussy up the portfolio and make it more presentable. When funds send out their quarterly update to investors, they don't want their top-ten list of stocks to look particularly heinous. It's okay to have one clunker in there, but two badly-performing stocks is pushing it and three is right out. And if your number 11 stock is, say, The Gap, which has risen 28.6 percent this quarter, why not bump that baby up to the 10 spot?
As a result of such window dressing, there is a tendency at the end of the quarter for stocks that have been performing well to see outsized gains against the market, while stocks that have been underperforming suffer.
When funds engage in marking up, they are trying to boost returns. The way it works, a fund company will buy heavily stocks it already has big positions in, which sends these stocks higher. The gains can be fairly large, because funds pick the more volatile names, where they can get the most bang for their buck.
The problem with window dressing and marking up -- besides the obvious point that it's a two-faced move -- is that such buying and selling is entirely artificial. Because the stocks aren't moving for fundamental reasons, the moves reverse themselves.
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