Top-down vs bottom-up investing: which is right for you?

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

Drop the little yellow figure onto a street in Google Maps and you’ll see all the shopfronts, maybe even the shape of the landscape, and a bit of a feel for the area. Zoom out to the classic view and what you lose in detail you gain in transport routes, big landmarks and enough info to help plan your week-long trip rather than just your afternoon.

It’s the same when we talk about bottom-up and top-down investing. The former helps us examine companies on their own steam, with the latter sacrificing that business-level view for more of a focus on which way the global economic winds are blowing. And, just like intrepid travellers will argue over which way is best to plan a city break, investors often have their preferred routes to analysing stocks for their portfolios.

Let’s break down both to see which works best for you.

We’re looking at the big picture here. The theory is that once we’ve got a grasp of where the likes of inflation, interest rates, economic growth and geopolitics are headed, we can then distill that into an investment thesis and look for the stocks to fit that narrative.

How does that work in practice?

Well, cast your mind back to August 2020. Interest rates had fallen to 0.1% as the Bank of England tried to get us all spending again by making savings rates pretty unattractive. Inflation sat at 0.2%.

The Bank of England uses interest rates to try and tame inflation

Time travel quickly to October 2022 and, with UK inflation breaching 11% (a 40-year high), interest rates had risen to 2.25% in a bid to battle price rises. Top-down investors focusing on the hike in interest rates so far, and eyeing up a raft of rises to come, might have avoided rate-sensitive sectors like housebuilders and instead looked to those corners of the market with the ability to raise prices and keep customers on board, like energy. The country’s oil majors ended up being some of the FTSE 100’s top performers that year.

It might not have felt quite that simple - we’ve afforded the top-downers a crystal ball here - but the example still holds. This group’s main strategy was to make sure their portfolios reflected the country’s headline economic changes as opposed to unearthing an unloved or overlooked company hiding in the UK stock market.

• Helps identify trends and choose assets to match. Net-zero, aging populations, changing consumption habits - these are just some of the huge societal shifts investors are tapping into and using to inform which sectors they allocate their money to.
• Takes the home bias blinkers off. When we see the problems that might take a country years to shake or spot the regional opportunities starting to break through, it can open up multiple ways to explore a theme rather than being glued to one market, like the UK, with no idea of what’s happening elsewhere.

• Economic forecasting is a tricky business. The path for interest rates or inflation is rarely completely straightforward and they aren’t the only thing out there influencing markets. The outbreak of war, commodity shortages, disruptive technologies - we’ve all seen these over the past few years and their common characteristic is how hard it would have been to predict them all and their effect on economies and markets.
• Even if a theme leads you to a sector, there’s no guarantee you’ll pick the best stock. Companies face individual hurdles that a broad shift in market sentiment can’t account for. Basing a stock pick solely on the bigger picture risks missing the finer nuances of the business.

If you’re more concerned about what a business is doing to take control of its own future, regardless of what’s happening in the wider economy, you might be a bottom-up investor. The macro data might be useful for the top-down crowd but in this part of the market, revenues, margins and profit-fuelled growth are the yardsticks.

The thought process here is not about ignoring the world out there, it’s just that bottom-uppers think delving into companies tells us more about their performance than the overarching environment. Arguably, a company should be able to operate regardless of what’s happening in the world, or at least not be shoved around by the latest headline.

A useful example here comes via the nation’s supermarkets. While inflation was hurting household budgets in the same time period we looked at earlier, bottom-up investors might have looked at how well the big names (the blue one and the orange one, you know who they are) were absorbing that hit to margins and keeping prices low for cash-strapped consumers. On-the-ground investors might have also noticed how they were starting to match the four-letter-named German discounters on price and ramp up their own loyalty schemes.

While the bigger picture pointed to consumer struggles, it didn’t factor in how resilient some companies were and how they were navigating the environment with customers and competitors in mind.

• If you are putting the big picture to one side and trying to find companies whose accounts can demonstrate consistency, resilience and adaptability, they should hopefully be able to deal with whatever economic headline hits them next. Pricing power (the ability to raise prices and hang onto customers) only really shows up when you’re close to the company reports.
• Allocating to sectors based on what’s happening in the country/world/industry more broadly is one thing but going one step further and finding management with a proven history of success, companies with unique market positions, and squeaky clean balance sheets is entirely another.

• Stock-specific risk is real. Some great companies can’t escape broader trends like tariffs or pandemics hitting their popularity, or high inflation meaning consumers change their shopping habits. Companies can rarely operate in an economic vacuum.
• Sometimes you can't see the woods for the trees. Digging into the detail isn’t a bad thing but it’s unlikely to reveal broader changes happening across sectors and geographies over time - something top-down analysis is good at spotting.

Fund managers will often staunchly stick to one of these approaches but the good thing is you don’t have to. There’s nothing to stop you researching a sector because you work in it or are just interested, looking at how the high level picture is set to develop and how the economic landscape (inflation, interest rates etc.) might affect that, then exploring the stocks that could benefit, focusing on balance sheet strength and any specific advantages a business carries.

For example, an aging population might have you looking into the healthcare space, specifically for firms addressing later-life ailments. If there are any, you might look at drug pipelines, balance sheet strength, margin stability and a whole host of company characteristics.

In this sense, you’d be using a top-down lens to help refine your bottom-up stockpicking.

In the end, there are positives from both approaches that you are free to nab and use in your own way. It’s never a bad thing to check the weather forecast before you leave the house - just make sure the coat you take with you isn’t full of holes.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.