Top-down or bottom-up investing? Check who is using which approach

NEW DELHI: When the stock market on an uptrend, a ‘bottom-up’ approach to stock picking work best, while in a weak market, a ‘top-down’ approach comes handy.

That’s an inference drawn by foreign brokerage Bank of America-Merrill Lynch from a study of some 1,600 Indian mutual fund schemes.


In a ‘bottom up’ approach, investors focus on individual companies rather than a whole sector to which the company belongs or the economy as a whole. The ‘top-down’ approach works the reverse way.

In top-down approach, investment decisions are based macro parameters, such as the health of the economy or sector, which is then broken down to look at smaller components and their potential impact on a sector or a set of stocks.

In the study, BofA-ML found that only 3 per cent of the 1,600 equity funds actually managed to outperform Nifty in the first six months of 2018 while 6 per cent of them outperformed on a relative basis in last one year and 16 per cent in last three years.

“Sectoral allocation does not matter in a strong market, when it is all about stock picking. But it does tend to add value in a weak market,” the brokerage said.
Based on its cautious outlook for the Indian market, the brokerage said perhaps it is time for Indian investors to increase focus on ‘top down’ investment.

Kalpen Parekh, President at DSP BlackRock Mutual Fund, says the recent underperformance of some of DSP’s own schemes were due to their under-ownership of the export-led IT and pharma stocks.
Which in a way validates the argument that sectoral preferences do have a part to play in a weak market.

BofA-ML is currently overweight on Indian discretionary, financials and industrials and underweight on healthcare and IT. It has also cut its stance to neutral on staples.

According to a study by Motilal Oswal Securities, at the end of May, technology (16 funds under-owned), consumer (15 funds under-owned), private banks (14 funds under-owned), oil & gas (14 funds under-owned), and utilities (13 funds under-owned) were some of the sectors where domestic mutual funds were underweight by at least 100 basis points compared with these sectors’ weightages in the BSE200 index.

“On a month-on-month basis, weights of financials, technology, consumer and oil stocks have increased, while those of capital goods, healthcare, auto, metals, infrastructure, cement, utilities, telecom, real estate and chemicals have moderated,” Motilal Oswal Securities said in a note.