What is top-down investing?
Top-down investing is an investment analysis approach that first analyzes macro factors in the economy, such as GDP, employment, taxation, interest rates, etc. before examining micro factors such as specific sectors or even companies. This approach gives priority to macroeconomic, national or market-level factors.
Top-down investing can be contrasted with the bottom-up approach, which begins with the fundamentals of a company first, where the focus is on, and then moves up the structural hierarchy, looking last at macro economics. -global, if not at all.
Key points to remember
- Top-down investing is an approach that first focuses on macroeconomic factors such as the performance of a national economy or major industrial sectors to guide investment choices.
- Top-down investing can be compared to bottom-up investing, which instead focuses on the performance and fundamentals of individual companies.
- Top-down investing can help investors save the time and attention they need to devote to their investments, but can also miss out on potentially profitable individual investments.
Understanding Top-Down Investing
When looking at the big picture, investors use macroeconomic variables, such as GDP, trade balances, currency movements, inflation, interest rates, and other aspects of the economy in his outfit. After looking at general conditions around the world, analysts then look at general market conditions to identify the best performing sectors, industries or regions in the macroeconomics. The aim is to find specific industrial sectors which should outperform the market.
Based on these factors, top-down investors allocate investments from efficient and diversified asset allocations, rather than by analyzing and betting on specific companies. For example, if economic growth in Asia is better than domestic growth in the United States, an investor could move their assets internationally by purchasing exchange-traded funds (ETFs) that track specific Asian countries. From this point on, they further analyze the stocks of specific companies to choose which ones might be successful as investments by last examining the fundamentals of a particular company.
Advantages and disadvantages
Top-down investing can make more efficient use of an investor’s time and attention to relevant data, as it primarily depends on examining large-scale economic aggregates and readily available public data and involves choosing from relatively few. regions or general sectors as opposed to the whole universe of stocks of individual companies.
However, it can also miss out on a large number of potentially profitable opportunities by eliminating industrial sectors or entire countries from consideration, even the companies within it that outperform the general market.
From top to bottom versus from bottom to top
Bottom-up investing is the opposite strategy to top-down investing. Bottom-up practitioners ignore macroeconomic factors and instead examine the individual microeconomic factors that affect the specific companies they oversee.
Top-down investing can produce a longer-term or strategic portfolio and favor passive index strategies, while a bottom-up approach can lead to more tactical and actively managed strategies. Top-down portfolios often consist largely of index funds that track specific regions or industry sectors and may include commodities, currencies, and some individual stocks. Bottom-up style portfolios often have a much larger share of individual stocks.
For example, a bottom-up investor chooses a company and then looks at its financial health, supply, demand, and other factors over a period of time. While there is some debate as to whether the top-down approach is better than the bottom-up strategy, many investors have found top-down strategies useful in determining which sectors are most promising in a given market.
Example of top-down investment
As an example of top-down investing, UBS hosted its 2016 UBS CIO Global Forum in Beverly Hills, California to help investors navigate the economic environment of the time. The forum addressed macroeconomic factors that affect markets, including international government policy, central bank policy, international market performance and the effects of the Brexit vote on the global economy. The way UBS has handled these economic factors indicates a top-down investment strategy.
Jeremy Zirin, a wealth manager who is part of UBS Wealth Management Americas, spoke about the benefits of top-down investing at the forum. Consumer discretionary stocks looked attractive to Zirin and his team, who implemented a top-down approach to identify strong investments in consumer discretionary. His team took the above macroeconomic factors into account and found that consumer discretionary was insulated from international risks and was bolstered by the purchasing power of US consumers. Identifying this industry has allowed him and his team to identify Home Depot as a good investment.