Equity Portfolios: Investment Styles

There are two ways to start assembling a portfolio - two styles which investment managers commonly use to describe their selection technique.

A top-down approach begins with an assessment of current situation and future trends in the background social and economic environment. You form an opinion on the relative attractiveness of different industry sectors given this wider view - leading you to select specific companies within those sectors which you believe are best-placed to benefit most from the broad socio-economic (and political) developments you’re seeing.

You can look for rising stars (growth investing ) or neglected companies (value investing ) from the top-down, but this approach tends to be the hallmark of the growth investor - relying initially and significantly on the ‘big picture’ to guide investment decisions; which are then followed-up by a check for financial soundness.

A bottom-up approach aims to identify attractive shares by starting with an assessment of a company’s operations. Attractive companies are initially identified without reference to industry sector or wider socio-economic trends.

This focuses stock selection on ‘quantitative’ financial figures - the company’s accounts - as a ‘qualitative’ judgement about a company can only be made with reference to its competitors and markets. Software screening programmes are often used to sift through the universe of stocks to find those whose financials pass strict criteria for efficiency, debt coverage etc. Hardcore financial analysts take the ‘instinct’ out of stock-picking and believe that the figures alone can provide enough information to stock-pick. But the majority of professional investors will use business risk analysis to back-up a financially-based recommendation.

The most sophisticated investment style -whether top-down or bottom-up, will also run any potential stock-picks through rigorous quantitative analysis.