Window dressing in equity mutual funds

Abstract

This study examines the relationships among window dressing (WD), portfolio concentration, fund flows, and fund performance in Taiwan’s equity fund industry. Our empirical analysis documents that the WD phenomenon exists in equity mutual funds with poorly performing fund managers who are more likely to conduct WD activities. Funds with concentrated investment in their top 10 shareholdings are more likely to do this, and there is also a stronger year-end WD effect, showing that fund managers are more prone to improve the appearance of their portfolios at that time versus at other quarter-ends. Funds with higher WD activities tend to have poor performance during the quarter, but have a larger (smaller) proportion of winner (loser) stocks at the end of the quarter. In addition, fund managers typically buy winners at higher prices and sell losers at lower prices near quarter-ends. The highest WD quintile funds encounter lower long-term fund flows, and funds with higher WD activities experience poorer long-term performance. Finally, fund managers’ portfolio rebalancing more closely correlates to the agency problem than to momentum trading or tax-loss selling.