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Top-down/Bottom-up Approach

Please explain the concept of top-down approach and bottom-up approach of investing implemented by fund managers.
-Sandeep Sahasrabudhe

Please explain the concept of top-down approach and bottom-up approach of investing implemented by fund managers.
--Sandeep Sahasrabudhe

Top down approach puts a lot of emphasis on macro-economic factors. In this approach, the fund manager first determines the sectors and industries which he expects to do well in the future.

Once he has identified the favorable sectors, he then goes about picking companies within those sectors which he considers investment worthy. For example, if oil prices start registering a sharp decline, a fund manager might form a view that this will stand to benefit the auto sector, and hence start looking for stocks of the companies operating in the auto sector.

In contrast, in the bottom-up approach the focus shifts from industry or the economy to company specific factors. Therefore, the implicit assumption here is that companies can perform well even though the sector/ industry in which they operate is not doing well. The bottom-up approach can get more challenging since there is a huge universe to pick the stocks from, unlike the top-down approach where the universe gets narrowed down to companies operating in select industries. However, it also presents the opportunity to discover some value bargains which otherwise could have been missed in a top-down approach as a result of omission of that industry.



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