when performance has been lagging fund managers may sell stocks that have reported substantial losses and replace them with stocks expected to produce short term gains to improve the fund s overall performance for the reporting period 
investors should pay close attention to holdings that appear outside of a fund s strategy and the assets that have been replaced for example imagine that a fund investing in stocks exclusively from the s p 500 has underperformed the index stocks a and b outperformed the total index but were underweight in the fund while stocks c and d were overweight in the fund but lagged the index to make it look like the fund was investing in stocks a and b all along the portfolio manager could sell out of stocks c and d replacing them with a and b this would also give an overweight to stocks a and b another way is for a manager to purchase stocks that do not meet the style or strategy of the mutual fund for example a precious metals fund might invest in stocks that were performing well and disguise them this gives the fund the appearance of a short term performance boost that is not aligned with the market or indexes it might mirror though disclosure rules are intended to aid in increasing transparency for investors window dressing can still obscure the practices of the fund manager there are some techniques you can use to identify window dressing first ensure holdings match the index the fund tracks if it is an index fund if it isn t an index fund make sure they meet the fund s published intent most funds have a description of what they are designed to invest in usually called the fund s objective for example the fidelity value fund s fdvlx objective is to seek capital appreciation using a strategy of valuating companies with valuable fixed assets and purchasing the stocks of the ones it believes are undervalued 1if you found holdings in this fund you believed didn t fit the objective and strategy it might be window dressing but then it might not because the fund s valuation methodology might allow it to change holdings second look over the fund s holdings and compare the returns of each one for instance fdvlx had more than 200 holdings on jan 31 2023 with the top ten stocks making up slightly more than 10 of the fund if you look at the fund s monthly holding report you can find each stock s ticker and evaluate it by comparing holdings from month to month you might also see them changing and be able to investigate performance differences between the old and new ones 2third use these reports to identify past and current turnover and determine when it occurs there might be a pattern of turnover such as a majority of stocks remaining in the fund s holdings with several non performers turning over at intervals that don t make sense this could be regular fund management but it pays to take a look finally look at the fund s management fund managers lacking trading acumen or who have experienced poor performance in the past are more likely to window dress good funds have experienced ethical managers that do not need to window dress window dressing in accountingpublicly owned companies must follow specific accounting guidelines that ensure investors and regulators have a transparent view of financial performance some hire accounting firms to ensure their books are kept up to date and that reports are generated there is always the chance that management or leadership will not like the results seen on these financial reports so they may try to make changes to accounts or accounting methods to make it look like they performed better than they did the most significant reason a business would window dress its financial reports is to ensure they don t lose investor interest investors and lenders make up a large portion of a company s fund raising efforts lenders use these reports to make lending decisions and investors use them for investing decisions therefore lower financial performance can mean less funding not all accounting window dressing is so evident as changing some numbers here are a few examples of changes in accounting methods 3it s important to understand that many businesses are honest and trying to do the right thing looking out for window dressing should be part of your tool kit when you re evaluating investment opportunities just in case you come across a company that is trying to cook the books or deceive you while difficult to determine you can identify window dressing by studying past financial reports and reading about a company s activities via their news releases and investor reports you may be able to identify discrepancies between them for instance examine the cash flow statement to see where cash is coming from and where it is going then compare it to cash flows from the last few periods if there are significant changes you should be able to find a summary in the investor or financial reports with a description of why it has changed if you don t see it you may want to investigate further look for a change in accounting procedures a company should publish that they began accounting differently for something recently in fact publicly traded companies are required to report accounting procedure changes look for increases in valuation a dramatic increase in sales that doesn t correspond to past seasonal or cyclical sales or another issue that might raise an eyebrow 