Money Matters - Investments. "Beware of geeks bearing formulae"
Are you someone that likes to see the bigger pictures, that builds schemes and frameworks for, or are you someone that likes to see the detail and likes to build a clock rather than tell the time?
Top Bottom What?
This area is actually a lot more simple than you think. Top down basically means that you approach investing with a strategy and then you look through that strategy to find something to plug a gap.
You might decide to run a portfolio with 25% UK Equity, 25% US Equity, 25% Bonds and 25% property. This is top down, because then you’ll pick the best fund you can find to occupy each category.
The downside here is that you can miss out on opportunities as you may not have enough space to do everything you want within one allocation.
Bottom up means that you look for ideas that you think will work and then buy them with part of your portfolio. So you might see an opportunity with Aviva plc. and buy shares there, You may feel that tracking the us equity market might be a good idea and buy that, then eventually you’ll end up with a portfolio full of your best ideas.
The downside here is that you might overbalance your portfolio on one theme, such as commodities, and then when that sector gets hit, you get hammered.
We build bespoke fund of funds and so, by nature are top-down, but I’ve come across many successful investors who have pursued a bottom up strategy and picked some absolute crackers.
These two terms are not as complicated as they first appear. The fundamentals of a company are essentially the books, what is actually happening on the ground. Whereas the technical is the stock, how the markets are reacting with this stock in particular in a wider economic context.
So the argument is as follows:
Some investors prefer to look at the fundamentals, does the company have good cash flow, can they afford their dividend, is the board of sufficient quality to strategise long-term growth, are the executive team quick enough to react to short term opportunities.
This can come unstuck. What if a company with incredibly strong fundamentals loses its supply chain? There were many companies in Birmingham in the 60’s and 70’s with incredibly strong fundamentals, but it actually turned out that the money that drove most of them was actually sourced in the motor industry. When some pulled out, the whole city’s economy collapsed. Thankfully Birmingham has recovered and is the third most popular city in the UK to do business behind London and Manchester.
Some investors prefer to look at technicals, which are incredibly complex. Essentially, these investors look at a graph like the one below and try to work out what the stock is going to do next by the mathematical rules of the marketplace.
So, if you look at around 9:55 a lot of people have been buying above the upper Bollinger band, which is effectively the upper bounds of what the volatility says would be a normal trade.
As you can see, selling out there at around £2.37 came before a mini price collapse and you could buy again at around 10:20 for £2.35, when it falls below the moving average. Such micro-trades can make small percentage gains every day.
The downside to this approach is that the rules are meant to be broken and you miss the point of what you are investing in. Long-term investing is less well suited to technical analysis.
This is the last article on investment styles. Next week we’ll talk about building an ‘ideas matrix’ that you can slot all your ideas into and then work out the perfect investment for you, based on what you believe in.
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