Getting ahead of the big money institutions to buy outperformers and sell underperformers
Each quarter, mutual funds and other institutions divulge their stock holdings. Window dressing is when portfolio managers buy outperforming stocks just before the end of the quarter, so that someone looking into their holdings thinks they have been investing in great stocks. Similarly, they may sell their underperforming stocks to hide the fact they have invested in losing companies. This week, I am looking for quantified evidence of this dubious practice, and then will look at some stocks these institutions may be targeting before the end of the quarter.
Window Dressing Evidence
There is evidence that windows dressing is, in fact, happening. Going back to 2013 using current S&P 500 Index (SPX) stocks, I picked a point two weeks before the end of each quarter, which corresponds to today. Then, I found the 50 best and worst stocks over the preceding six months. According to our window dressing theory, you would expect the best performers over the previous six months to also outperform the last two weeks of the quarter, as institutions add them to their holdings. Similarly, you would expect the underperformers to lag, as institutions sell those stocks.
The first table below shows the average returns over the last two weeks, based on their return over the previous six months. Looking only at the second and third quarters, they behave exactly as you would expect if window dressing were occurring. The top six-month performers do the best over the next two weeks, while the six-month laggards do the worst. The second table shows the percentage of stocks that beat the S&P 500 Index. Interestingly, the first and fourth quarters show the exact opposite, as you would expect according to the window dressing theory. Perhaps those returns are being more influenced by other factors.
This being the third quarter, I list stocks to target based on our window dressing theory. Our goal is to get in front of the big money institutions padding their portfolios, buy the outperformers, and sell the underperformers.