I thought it would be good to do a post about these two approaches. I set as the French versions of Top-Down expressions (down) and Bottom-Up (up), but I'd rather use English phrases as most Francophones use also use them in English.
Let's start by explaining the difference between top-down and bottom-up. An investor who calls himself top-down investments in equity securities based on its analysis and its general macroeconomic outlook for various sectors. For example, an investor who refuses to invest in European banks because it feared the adverse effects of debt problems rulers of several European countries made a top-down analysis of the situation.
Conversely, an investor who focuses solely on corporate earnings, regardless of the overall situation surrounding the sector or the economy is said to be bottom-up. Thus, he who refuses to invest in European banks because they have high leverage, low profitability and are facing increased competition from foreign banks made a bottom-up analysis.
The big question remains to know which approach is preferable. This is a difficult question to answer because both approaches have elements positive. Moreover, few investors have an approach that can be called 100% top-down or bottom-up 100%. I think the best would effectively combine the two. Here's why:
1) The top-down approach to understanding what are the areas that we should expose. If we believe the economy will recover and that U.S. consumption will leave a great champion, then we would be exposed to cyclical sectors. Conversely, if we see major problems ahead, he would rather opt for the so-called defensive sectors.
2) Once selected sectoral exposure, a bottom-up analysis will select best companies that will allow us to position our portfolio to address the objectives of paragraph 1.
Why not just go for a top-down approach? Because according to this approach, once you've determined the sectors that it is better to expose the companies to buy does not matter. Naturally, the investor will not buy top-down business largely overstated, but the analysis at the enterprise level will not be pushed too. A top-down investor who believes that the Canadian banking sector is a must in any portfolio could well buy the Royal Bank, TD Bank, BMO and CIBC.
Why not go approach purely bottom-up? Because according to this approach, simply find the value in a company to establish a position, no matter how macroeconomic conditions. The bottom-up investor might well find much value in the titles of European banks, Canadian banks, American banks and Asian banks. Since this investor has no top-down analysis to determine the target weight for each industry, it could be 80% of its portfolio in the banking industry.
investor using the two methods will first banks that some regions are overweight in the portfolio, but some areas are avoided. After analysis of each bank, it could, for example, initiating positions in a Canadian bank, one American and one Asian.
For my part, I make a short top-down analysis to see how I would position myself and then my bottom-up analysis tells me to take the securities in which positions to meet my goal top-down. And you?
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