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Top down or bottom up?

Analyst Kate Marshall looks at the pros and cons of these two styles of fund management.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

All investors start with the same goal: to make a profit. Yet they go about it in different ways. Fund managers employ two main methods of choosing shares, 'top down' and 'bottom up'.

For top down investors the big picture is the most important thing to consider. They examine wider economic trends, aiming to forecast which industries or geographical regions will generate the best returns. A great company may not make a great investment if it is in a declining industry, for instance, so focusing on growing areas could lead to better profits in the long run.

Similarly, some managers seek to identify themes or long-term trends as a basis for stock ideas. For example, the fund managers at Newton employ a global thematic approach to capture the long-term developments that are driving change in the world around us. Of course the share price of the company should also meet the manager's opinion of fair value, but the starting point is global trends.

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No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

The Newton Global Higher Income Fund, managed by James Harries, is currently constructed around themes such as 'healthy demand'. In the West, rising longevity is leading to ageing populations and increased demand for healthcare, while individuals in some developing countries are becoming more affluent and able to spend more to meet their healthcare needs. As a result demand for healthcare could rise rapidly over the coming years.

Bottom up investing focuses on the individual attributes of a company or 'fundamentals'. Bottom up investors hunt for profitable investments by understanding businesses as fully as possible, getting to know their strengths and weaknesses. It means digging through company reports and news releases looking for anything the market may have missed, or carefully analysing balance sheets to establish the financial position of the company. For many fund managers it also means questioning company management.

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The sector or geographical area the company operates in is of secondary importance to bottom up investors. The approach is to find assets that are undervalued by the market, whichever sector they may be in, and hold them until they receive wider recognition and are more fully valued.

Most fund managers focus on bottom up investing, and all will include it to some degree. Some of our favoured funds which primarily adopt a bottom up approach include the Marlborough UK Micro Cap Growth Fund. It is managed by Giles Hargreave who has one of the strongest stock picking records in the UK Smaller Companies sector, according to our analysis. He conducts detailed analysis on individual companies and places great emphasis on meeting company management.

Other investors combine the two approaches. Take Neil Woodford, manager of the Woodford Equity Income Fund. Primarily the manager is a stock picker searching for undervalued companies with good earnings prospects, in his view. He combines this analysis with his assessment of wider economic conditions resulting in a high conviction portfolio meaning the fund often has significant exposure to individual stocks or sectors.

Newton Global Higher Income Fund KIID

Marlborough UK Micro Cap Growth Fund KIID

CF Woodford Equity Income Fund KIID

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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