Anyone who has a job has devised various tricks to make work easier or avoid it altogether.
Well, fund managers are no different. Like almost everybody, they have their collection of tricks to shirk work or even boost their performance.
Lately, you've probably been reading about what's called window dressing. At the end of a month or quarter, portfolio managers will load up stocks that have done well to make their top holdings look impressive.
Well, this is just one ploy you'd never know about from tracking a fund's portfolio or its performance. And there are others.
When Performances Belies the Portfolio
On Oct. 31, the fiscal year ended for many mutual funds, and money managers were engaged in the usual practice of window dressing. It goes something like this: A fund manager buys more shares of the stocks that have done well and pares the ones that look like losers. The idea is to make the top-10 list look like a bunch of winners. After all, that's what investors see.
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And a fund manager also doesn't want to end a month or a quarter sitting on a bunch of cash. They get paid to be fully invested. And cash looks bad. For example,
Fidelity Fifty manager John Muresianu butted heads with the firm's big shots over his tendency to carry a large cash position in the fund. Muresianu wound up leaving Fidelity earlier this year.
A manager might also look at the fund's biggest holdings and say, "Hey, defense stocks have done well. I need to own one -- at least temporarily. Maybe I'll buy
. That one looks good enough."
If the performance stinks, the manager can at least try to make the holdings look decent. Right?
And with so much focus on corporate scandals these days, a manager probably won't let a name like
appear as a major holding. The manager would sell just enough of it to avoid answering questions like: "Why do you own it? How could you own it? Why didn't you sell it?"
There's also the more egregious practice of using extra cash to pump up the prices of stocks that the fund already owns. It can be and is done by buying more shares of less liquid stocks. A buy of a few hundred thousand shares can make a difference with a thinly traded stock, pushing the stock higher and making a fund's overall return look better. After the fund's quarterly performance is computed, the manager can trim back the position.
Of course this little game is seen as stock manipulation by securities regulators. But hey, if they didn't catch Enron, WorldCom or Tyco, do you think they'll nab somebody for a little extra trading?
Trading Out of Boredom?
Some managers don't just trade to make their portfolios look impressive at the end of a reporting period. They buy and sell because, well, they like buying and selling.
This action might prevent a manager from falling asleep at work, but it'll cost you if you're a shareholder in that fund. Trading costs, such as commissions, come out of a fund's returns. And if a manager is a real numbskull, he might be realizing taxable gains, which are passed on to shareholders, or simply buying high and selling low.
Managing an Index Fund With Better Pay
Actually, some fund managers are quite happy to lay back and lazily run a fund that looks just like a broad stock-market index, like the
With a fund that has billions of dollars in it, it's going to be hard to beat the market handily anyway. It's easier to closely track the index than risk having a big bet on a industry or stock blow up in your face.
If that happens, the manager's paycheck is going to take a hit. A fund's performance relative to a benchmark like the S&P is used in calculating the compensation of many fund managers. That's why you'll see
as big holdings in so many funds.
If you own a fund that acts a lot like the S&P 500 -- week after week and month after month -- then that manager might be mimicking that index. And you can save yourself some money by simply buying an index fund.
Who Needs Research?
Then there are the managers who will buy stocks without doing any research. Maybe a professional wants exposure to a sector like health care, and
Johnson & Johnson
is a stock everyone seems to like. If everyone else likes it, this stock has to be a good one. Who needs an actual analysis of the company?
And then you wonder why so many funds owned Enron before it blew up. It wasn't that fund managers missed the shenanigans when analyzing the company's results. Some of them probably never bothered to look.