US windows dressing 2013, Julius Baer’s Riniker explains

Christoph Riniker, head Strategy Research at Julius Baer, goes through institutional investors’ portfolio review process for 2013.

US windows dressing 2013

– Towards the end of the fiscal year, institutional investors review their portfolios in order to reduce losers and add winners. This is called windows dressing.
– Being carried out with substantial volumes these portfolio adjustments can have a major seasonal impact on individual equities and even stock markets.
– Investors may take advantage of this strategy by selecting companies that have so far outperformed the overall market substantially in 2013 or going short lagging stocks.

What is window dressing?

Towards the end of the fiscal year, institutional investors such as fund companies typically review their portfolios and reduce positions in underperforming stocks (so-called losers). In turn, holdings in outperforming stocks (winners) are maintained or even increased. As these portfolio adjustments can often involve substantial volumes, they can have a major seasonal impact on individual equities and even stock markets. Outperforming stocks tend to perform positively in the following weeks while the underperformance of the losers is often confirmed as well.

In years with absolute negative returns, window dressing could still be of importance, as institutional managers, for example, want to reposition their holdings for the year-end reporting and future upswings. Hence, we expect institutions to liquidate their worst-performing positions, putting further pressure on markets, particularly on the laggards mentioned in this report. In contrast to Europe, the majority of US mutual funds have their fiscal year-end at the end of October and will hence clean their portfolios mainly in September. Consequently it makes more sense to look at the US window dressing season separately. In Europe where the average fiscal year ends with the calendar year, the adjustments will take place later (a separate study is scheduled to be published in December 2013). Due to market liquidity, the window dressing is carried out before mid-December.

What market data tells us

Taking market data back to 1980 into consideration, the result suggests that the approach works better for the winning side. Winners are defined as the stocks, the relative performance of which in the first eleven months of the fiscal year (i.e. November to September) is trading in the top quartile. Opposite losers are positioned in the bottom quartile. On average 54% of the stocks which have outperformed in the first eleven months of the fiscal year (median relative total return compared to MSCI USA at 44.6%) have also shown a positive return in the months from October to December (median at 13.5%). Only 46% of the laggards (median of -25.3%) continue their underperformance in period two (median of -11.2%). Be aware that confidence levels are low and that there are substantial differences in hit ratios when looking at the single years.

How to take advantage

Investors may take advantage of this strategy by selecting companies that have so far outperformed the overall market substantially in 2013 (i.e. being in the top quartile) and are Buy rated by our JB analysts. In turn, they may go short companies that have relatively underperformed and are Hold or Reduce rated.

Going short the losers

The 2013 loser portfolio includes the names shown in the table below. While the long-term trend suggests an underperformance of circa 25% so far, this portfolio ‘only’ lost 15% on a relative basis compared with MSCI USA. However, the continuing trend should remain negative.

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