Equity Funds: Top Down and Bottom Up Approaches

What is the top down and bottom up approach in equity funds and what is the ideal choice of the two when evaluating equity schemes? Read on.

The “Top Down” and “Bottom Up” Approach to Investing in Equities

Equity Mutual Funds

A Price Waterhouse Coopers report, published right after the General Elections of 2014, predicted that the private equities market would revive and contribute significantly in the building up of India’s success story over the next couple of decades. If you have already contributed to the success story by investing in the best equity funds in India, it is definitely time to sharpen your analysis of the investment markets to make the right calls. So, should you adopt a “top down” or a “bottom up” approach for evaluating your equity instruments? Here are some insights.

What the “Top Down “Approach Means

“Top down” investing is about looking at the holistic picture or the “big picture”. Here, the investors take a close look at the economy first, and try and forecast which industry would be generating the best and the maximum returns and why. Once the winners or the prospective winners have been identified, investors hunt for specific companies within these sectors and the stocks are then added to the portfolios in equity funds. So, if you think that there would be a drop in home loan interest rates, you may also predict that the residential real estate markets would do well as a result of this drop. And, the search can then be limited to the topmost players in this sector and one or few can be chosen for asset allocation.

What the “Bottom Up” Approach Signifies

This approach is the reverse of the one above. It overlooks the economic conditions and the broad sector, and focuses on the stocks depending upon the specific attributes of the company. So here, the fund manager would be seeking robust companies with healthy prospects, irrespective of the macroeconomic factors or the industry it is a part of. However, what qualifies as a good prospect is purely a matter of opinion. While some would find earnings growth as effective pointers, others will prefer companies with low P/E ratios attractive. The health of the company is all that matters here, irrespective of the financial conditions of the market.

The Ideal Approach

When it comes to equity mutual funds, the best ones to opt for are a combination of both approaches in order to ensure maximum performance. Skilled fund managers are those who have built trust over the years with well performing funds. An equity scheme worthy of investment should be one that does not resort to any biases when choosing the companies to invest in.