Window Dressing in Mutual Funds

This paper introduces two measures to investigate potential window-dressing behavior amongmutual fund managers. We show that unskilled managers that perform poorly are more likely towindow dress by strategically purchasing winner stocks and selling loser stocks near quarterends. Further, funds with higher expense ratios and greater portfolio turnover are associated withmore window dressing. We also find that funds involved in window dressing perform poorly inthe following quarter. Given these adverse effects, we demonstrate how window dressing canexist in equilibrium. Current reporting requirements allow managers up to 60 days’ delay toreport end of quarter portfolio holdings. We show how window-dressing managers can benefitfrom incrementally higher fund flows if good performance is realized during the delay period.However, we find that poor performance results in incrementally lower flows than that observedfor non-window dressing managers.