Investment style and techniques - 1 - Veterinary Practice
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InFocus

Investment style and techniques – 1

GORDON NICOLL
introduces a new series explaining
some of the methods and strategies
that fund managers adopt in
managing investments

ONE of the benefits of entrusting money to professional fund managers is the knowledge that these individuals are taking responsibility for the day-to-day decisions relating to the assets in the portfolio. There is a process of research and analysis to support each decision, which is not widely understood. In the course of this, and subsequent articles, I will endeavour to explain some of the investment styles and techniques that the fund managers adopt in managing investments.

Top down and bottom up

These are terms which refer to how fund managers structure their portfolio. Bottom up is a method that places the influence of economic and market cycles after fundamental analysis of the company or investment has taken place. Strong companies are identified irrespective of the sector or geographic region they operate in. This approach may lead to a manager investing in sectors or regions which other managers consider to be out of favour. The bottom up approach assumes that strong companies can do well even in a challenging market or economic conditions. Making sound investment decisions based on a bottom up strategy requires a thorough review of the company in question and detailed understanding of the factors that may influence the future performance of that company. This research will include detailed scrutiny of the company accounts, gauging their financial stability, and may involve face-to-face questioning of the senior management team to understand future business strategy. Stock picking is a key part of the bottom up process where a fund manager uses systematic analysis to conclude whether a particular stock will make a good investment and, therefore, should be added to the portfolio. Stock picking can be a very difficult process because there is never a foolproof way to determine what a stock’s price will do in the future. However, by examining numerous business and financial indicators, a manager should be able to get a better sense of future stock prices than by relying on guesswork. However, as forecasting is not an exact science, a fund manager who uses any forecasting technique should include a margin of error in his or her calculations.

A wider view

A top down investment approach involves taking a wider (or macro) view of the financial world, i.e. the future direction of interest rates or the economy as a whole. This will lead to certain conclusions being drawn on sectors or markets that may do well. These areas are then considered in further detail, for example different industrial sectors may be analysed in order to select those that are likely to outperform the market in general.
Once the overall portfolio allocation is formed, the manager then begins the process of selecting the underlying stocks within the fund. This approach may prevent the manager from selecting companies which offer significant potential over the long-term if they do not fall within the asset allocation parameters adopted by their current model. This differs markedly from the bottom up approach, as the drivers for individual stock selection are dependent on whether the company falls within a favoured sector, geographic region or
size. It is not easy to draw a black-andwhite conclusion on both styles. Even a manager who adopts a strict bottom up approach is likely to invest in the context of the wider market. In the face of a sustained, global recession, the merits of investing in even the most attractively valued companies needs to be tempered by the potential for further falls and the possibility that the company may, ultimately, fail. In my next article I will look at the distinctions between value and growth investing and the significance of a company’s ability to pay dividends. For further information or to discuss any aspect of financial planning, contact the author, a founder member of The Ellis McComb Partnership (an appointed representative of St. James’s Place Wealth Management plc), 3 Mortimer Street, Birkenhead, Wirral,
CH41 5EU; telephone 0151 650 6520, e-mail ellis.mccomb@sjpp.co.uk; website www.ellismccomb.co.uk.

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