Large Funds’ End Of Quarter Trading Impacts Market

| March 26, 2008 | 0 Comments

I just got off the phone with Southwest Airlines. Booking a flight to San Francisco was a breeze. I’m flying out to the bay area in April for a wedding. A good friend, Babe (yes that’s his real name) is settling down, tying the knot and marrying the girl of his dreams. While sorting out my travel plans I took a close look at the calendar and I realized a huge milestone was about to be crossed.

It’s close to the end of the quarter and suddenly some of the market volatility is making sense. I believe the recent rallies in the market are being caused by large funds dressing up their portfolios.

What do I mean by that?

Every investment manager’s graded on their performance at the end of every quarter – 4 times a year. It doesn’t matter if the investment manager’s running a mutual fund or a hedge fund, the end of the quarter is critical. It’s like the college student who slacked off all semester only to study hard and focus when it counts – at mid-terms and finals.

You’re probably asking yourself why the end of the quarter is so important to these guys?

Remember, fund managers handle millions and billions of dollars for investors.  They’re paid primarily on the size of their fund.  That’s right. The more money they manage the bigger their paycheck.  A nice job if you can get it.  Naturally they don’t want investors to pull money out. That would be very bad possibly leading to smaller paychecks, or heaven forbid, losing their jobs.

Every quarter these fund managers are closely examined.  How’d they do against the market?  What’s in the portfolio?  How’s their performance? Next Monday is the end of the quarter and these fund managers are going to do everything in their power to make their portfolios look good.

So what do they do?

Most of the investment dollars out there are invested long only (meaning they want the market to go up in value).  So, fund managers want to see their investments rally and provide good performance numbers. These managers engage in “Window Dressing”.  They dump small lesser-known stocks and anything performing badly.

Think about it, who wants to see millions of shares of Bear Stearns in their portfolio after the collapse?  Then they do their best to prop up stocks. They make the holdings look better by buying more and bidding up the price.

Is this legal?

Remember we are dealing with very smart people.  They won’t push a stock higher on the last day of the quarter.  No.  That’s just too obvious. Instead they will start bidding the stock up a few days prior to the quarter end.

I think a better question to ask is:  “Is this the right thing to do”.  Clearly the answer is no.  I firmly believe that this portfolio window dressing stuff is disingenuous.  Despite my feelings, it still happens.

Do fund managers really have the power to move stocks that much?  Of course they do, they manage enormous amounts of money.

Their buying and selling can have a huge impact on any particular stock. The impact is magnified on small and mid cap stocks with low trading volumes.  Fund managers know this.  Why do you think they slowly build into and out of positions?  A big buy order hitting the market would drive the price up significantly.  A sell order has the opposite effect.

So I wouldn’t look at this latest rally as a sign of a market bottom.  I still think it’s a bear market rally being driven by quarter-end window dressing from money managers.  I would expect the rest of this week to whipsaw as major institutions pretty-up their portfolios.

Can we make money on this phenomenon?

The best way to make money in this market is to stick to your convictions.  We’re in a confirmed bear market.  The best way to trade during these times is selling into a rally and buying on the dips.  I’m holding tight to my Nasdaq put options.

Buying near the money options on the various market indexes is another way to profit from these moves . . . just make sure you’re on the correct side of the trade.  Lastly, for those investors with long term horizons (5 years or more) now might be a good time to start averaging into quality stocks and ETFs.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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