Wednesday, December 19, 2012

"Soon Window-Dressing Won’t Work"

From DealBreaker:
Will it? I don’t know. The Wall Street Journal has a good article today about creepy stuff going on around window-dressing, where investment managers bid up the illiquid stocks they own on the last day of a quarter to make their quarterly numbers look good and increase their fee income and stuff. Sadly the Journal leads with its own study, which is kind of like statistics for people who don’t like statistics:
The Journal’s analysis compared the performance of those 10,000 stocks to the one-day return of the Standard & Poor’s 500-stock index. On days that didn’t end the quarter, an average of 217 stocks beat that index by at least 5 percentage points then trailed it by at least three the next day. But on the final trading days of quarters, an average of 280 stocks did.
Umm! There’s a chart of that, too, but … umm! Would you trade on that?1 Who cares, though; the Journal also cites forthcoming statistics from the Journal of Finance, which is like by, for and about people who love statistics:
[Let's talk about] Rabih Moussawi, a finance researcher at the Wharton School at the University of Pennsylvania who has studied window dressing. In a study slated for publication next year in the Journal of Finance, he and his colleagues found that the stocks most heavily owned by hedge funds outperformed the market by an average of 0.3 percentage points on the final day of the quarter — and underperformed by 0.25 points on the following trading day.
You could trade on that! Here’s what you do. First thing in the morning of the last day of each quarter, you buy a basket of $X worth hedge-fund-favored stocks constructed however they construct it in their paper – you can do it, I have faith in you, look at 13-Fs, etc. – and short an equal-weighted2 amount of S&P 500. Then, sell $2X of your basket at the close that day (and buy in 2x whatever you sold of S&P), leaving you short $X. Then, the first trading day of the next quarter, close out your short (and your S&P long). You’ve now made on average 0.55% of $X in two days. You can only do this once a quarter, for just 2.2% a year, but lever it a bit – why not, it’s market-neutral, etc. – or, more importantly, focus on small-cap and high-hedge-fund-concentration stocks that are more likely to get the most manipulated, and you start getting close to hedge fund returns. (I mean, low bar.)

HT: Market Folly