[THE VIEW] When to Watch Out for Portfolio Pumping and Window Dressing

Attracting Investors with Manipulated Performance
In-Depth Fund Analysis Is Essential

At the beginning of the year, it is common to receive a report card on the performance of the previous year. Funds managing assets are no exception, and those with good report cards actively advertise their achievements. This is because there are two main ways funds make money. One is through management fees proportional to the asset size, and the other is performance fees earned when achieving returns above a certain threshold.

If fund management performs well, not only can performance fees be earned, but high returns also appear attractive to investors, leading to more capital inflows into the fund. This increases the fund’s asset size, allowing for more management fees to be collected. Conversely, if returns are not high, the number of clients entrusting assets decreases, reducing revenue.

Even if immediate profits are not high, if a large amount of assets flows into the fund, the fund manager can generate income through management fees. Therefore, while asset management performance is important, sales strategies to attract many clients are inevitably crucial. However, to sell a fund well, it must appear attractive. For investors, returns are ultimately the key measure.

So, what strategies can fund managers adopt? For example, at year-end, if the performance for the year is poor, reporting the full-year results as is would mean submitting a bad report card and risking investor withdrawal. In such situations, a strategy used to manipulate the report card is artificially raising the prices of held stocks.

For instance, if holding stock A, purchasing additional shares can increase the price due to supply and demand principles. Stocks with low liquidity can have their market value temporarily increased with a small amount of additional purchases. This strategy is called ‘portfolio pumping.’

Portfolio pumping temporarily raises the asset value evaluated at market price, boosting the fund’s returns. However, the price increase from pumping is not due to fundamental value growth and is likely short-lived. Also, since stocks are bought at higher prices, there is a risk of greater losses upon selling. Several empirical analyses show that funds using portfolio pumping are more likely to incur long-term losses, ultimately harming investors, making it an undesirable strategy.

Another fund strategy is ‘window dressing.’ This term originates from the technique of displaying attractive products in shop windows to lure passersby. Similarly, funds may buy stocks with high recent returns just before portfolio disclosure to appear as if they hold popular stocks. This strategy aims to entice investors by making the fund look well-managed.

However, this does not improve portfolio returns. It is merely a strategy to deceive investors who check held stocks. Window dressing can attract investment funds in the short term but is ineffective in the long term. Funds employing this strategy often show lower long-term returns.

At quarter-end or year-end, there are many cases of new capital inflows or changes in investment destinations. Efforts to find better and more stable funds are important. However, to determine which fund is good, it is necessary to look beyond simple returns or short-term portfolio composition and conduct deeper analysis. This is because the world is full of false information and things that deceive people.

Seonggyu Park, Professor at Willamette University, USA

This content was produced with the assistance of AI translation services.