Portfolios are constructed and managed using a variety of strategies. Top-down and bottom-up investing are two commonly used approaches to portfolio development. In general, a top-down investing approach prioritizes macroeconomic projections above individual stock selection, whereas a bottom-up investing method prioritizes the latter. We use a mostly top-down approach that combines broad economic fundamentals into every step—from our general market forecast to the specific stocks we choose—to maintain strategic continuity.
The Downside of the Bottom-Up Philosophy
A bottom-up approach looks at individual securities as the major driver of investment results. Bottom-up techniques have drawbacks, such as a proclivity to over-concentrate in a specific area. If an investor only chooses stocks that they believe will do well or only specializes in one sector of the market, the portfolio may become narrowly concentrated. If other sectors of the market outperform, the concentrated portfolio underperforms.
Bottom-up investors typically downplay economic cycles while screening thousands of companies to find the best investments. Even the best companies are affected by macroeconomic trends. An investor may pick the best company in a sector, but if the sector does poorly, stock values can suffer.
The Upside to Top-Down Investing
We prefer looking for the haystack with the most needles rather than the needle in the haystack. Top-down economic analysis and market forecasts guide tactical decisions. This entails examining many macroeconomic parameters before choosing securities. Our economic forecast determines the portfolio’s stock, bond, cash, and other securities composition. Positive forecasts may necessitate heavy equity exposure, while unfavorable forecasts may warrant increasing cash exposure. We then choose countries, industries, and styles we expect to perform better to diversify the portfolio. From there, we can choose securities that match our assessments.
We think top-down investing affords us more tactical flexibility in changing market situations. It lets us modify a portfolio’s asset and sub-asset allocation based on our forecast of countries, sectors, and styles.
We further employ our analysis of the global economy across nations, industries, and market characteristics (growth vs. value, size, etc.) to ascertain our current market cycle position and the market sectors we wish to be exposed to. For instance, in later stages of market cycles, big, growth-oriented businesses typically fare better. A strong performance in this area could indicate the end of the market cycle.
The Bellinson Group is a Tokyo-based investment manager who takes a long-term, value-oriented, multi-strategic approach to investing.