Research Process: Top-Down, Bottom-Up, Or Both?
You may have once heard of terms like "Top-Down" and "Bottom-Up." In the investment world, these terms describe a process or means by which professional money managers or investors go about analysing the financial markets and proceeding to choose desired investments.
A top-down investor is someone who looks at the "big picture" view of the world first – looking at the global economy and developing a view on how it is first, before "heading down" to various geographic regions, countries or sectors and then proceeding to develop a view on each one of these segments and seeing which ones are more attractive for investment. Once a top-down investor has picked countries or industry groups that he or she favours, the investor will then "head down" to look at fundamentals of various companies and scrutinising them before deciding to pull the trigger. It is important to note that a top-down investor would find suitable investments based on his or her outlook on the "big picture." If he or she thinks that a global economic recession is imminent, a pursuit of a defensive investment strategy (like purchasing bonds and shifting to equities of defensive sectors) could guide the rest of the search process. Within the bond universe, in such a scenario, then sovereign bonds and investment grade corporate bonds would be expected to hold up significantly better as compared to high yield or non-investment grade bonds during a global recession.
Conversely, a bottom-up investor is essentially employing a process that is the reverse of a top-down investor, beginning first by looking at individual security details and scrutinising fundamentals (of an issuer or entity) before "heading up." Proceeding to develop a view of any industry or sector group is only done after developing a view on various entities and their respective securities that have been rigorously studied. In practice, most bottom-up investors may not pay attention to the macro events, focusing on the strengths of individual securities and expecting them to outperform their peers regardless of what is happening to the economy. Adopting such an approach would see investors remain unrestricted in the types of bonds they'd invest in during a global economic recession, as long as the bonds invested in and their issuers are fundamentally sound.
Some investors combine both approaches in their process; the important thing to note here is that no one way is better than the other. There is no fixed method, rule or golden formula.
The Research Team is part of iFAST Financial Pte Ltd.
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