Investing with a Top-down approach in Mutual Funds

The goal of every investor is to identify great stocks. Managing an investment portfolio successfully requires applying strategies that involve analysis of the investment. Investment analysis helps to evaluate different kinds of assets and securities, industries, trends, and sectors to gauge the future performance of an asset that will go with your investment goals. These strategies include two approaches, namely top-down and bottom-up investing. The choice of method depends on the investor’s individual goals, risk, and comfort level. In this article, we will discuss the Top-down Approach of investment.

What is Top-down Investing?

Top-down investing requires looking at the big picture of the economy’s macroeconomic factors in the first place. Then it identifies growing industries and sectors or regions within this prevailing macroeconomy. Finally, it chooses the best-performing company stock based on its fundamental and technical aspects.

How does the Top-down Investing approach work?

The macroeconomic factors such as the country’s economic growth or gross domestic product (GDP), the trade balances, geopolitical conditions, currency movements, inflation, interest rates, and other aspects used to formulate economic and fiscal policy are analyzed in this approach. The overall economy and macroeconomic factors, including monetary policy, inflation and others, drive the markets, commodity prices and ultimately stock prices.

The top-down approach examines economic factors to find how those factors may affect the overall market, specific industries, and ultimately, individual stocks within those industries. For example, suppose the economic factors are conducive to the growth and prosperity of an industry or sector. In that case, investors believe the said industry/sector will do well, and the stocks belonging to that industry or sector will also perform well.

Top-down investors are usually more opportunistic in their investment strategy and quick at entering and exiting markets to profit from short-term market movements.

When can the Top-down approach work well for investors?

The top-down approach works very well when macro factors primarily drive the market. The instances of global events in the past when all the asset classes across the board and the world were crashing or equities across the world lost, even when the markets were quoting at salivating valuations, a top-down approach was good enough to buy stocks.

For example, when the Mutual Fund manager feels that interest rates are likely to come down shortly, they invest in those sectors that are most likely to benefit from this event. For example, the Automobile and Real Estate sectors benefit from lower interest rates, and thus, the Mutual Fund manager goes for these sectors.

After these, the Mutual Fund manager employs the next stage of the top-down approach to analyze the specific companies within these sectors. The manager then goes for three or four companies in each industry and studies each company’s stocks’ fundamentals and relative valuations.

What are the advantages of the Top-down approach?

1. The advantage of the Top-down approach is its simplicity. In the top-down approach, targets are set globally. As directives are coming from the top, the message is sent to all departments uniformly. There is hardly a requirement of extra effort to realign each department’s endeavor.
2. This approach consumes less time to set the targets quickly for the whole business. No time is wasted in analyzing the performance of each department, and management can rapidly implement the decision to achieve the company’s goals.
3. The top-down approach is more accessible for less experienced investors who do not have time to analyze a company’s financial health.

What are the disadvantages of the top-down approach?

1. It is quick to implement, but the cost is likely to be higher.
2. It requires a lot of knowledge and expertise at the top level.
3. It experiences low participation and involvement of the lower management level and gradually decreasing motivation, which might negatively impact the effective working of the plan. Every department and its managers might not accept the company goals for their internal conflicts.

As a result, decision-makers may find that top-down planning is not producing expected results in every department.

The Bottom Line

A top-down approach starts with the economy, analyses the macroeconomic factors, and then specific industries that perform well in that economic setup. The last stage is selecting companies within that industry. While designing a balanced investment portfolio, it is vital to understand which method works better in what circumstances. Therefore always go for expert opinion to make the right decision.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh