Bottom-Up vs Top-Down Investing
Should investors pay more attention to macro-economic trends or to individual company characteristics when making investment decisions?
I am a bottom-up investor, because I think that approach is more actionable than the reverse.
First, let’s define what we’re talking about here. Simply stated, a macro, or top-down, investor is one who's very driven by what's happening with the broader economy. A bottom-up investor is one who's more focused on doing individual company research.
To play Devil’s advocate for a moment, one reason someone might favor a top-down approach is if they believe asset allocation across an entire portfolio is more important than the individual assets they own. This approach would have you focusing on questions like “asset class” before you ever start considering individual companies.
In my view, however, while my decisions are certainly informed by the broader economic context, I’m not putting money behind an economic trend. I’m putting money behind a company. The bet I’m making is on a specific asset, not the overall market environment.
In many ways, it’s easier to be a bottom-up investor than it is to be top-down. Finding pockets of investable companies right now is more difficult than it’s been in the past, but it’s a lot more actionable to be a bottom-up investor than the reverse. That’s because I can understand what a company is doing more readily than what “the market” as a whole is doing. I can look at what customers think about that company, and I can make clear judgments about the company’s management, moat, and performance.
However, it’s not an either/or. Both top-down and bottom-up approaches have a role to play.
I do bring in the high-level macro view when I deal with valuation, what discount rate I apply, and what risks I’m thinking about. At the end of the day, we’re trying to determine how much to pay for a stream of future cash flows, and that requires incorporating the broader economy into the assessment. How are these companies going to handle a given set of macro-economic risks, and are those risks accurately priced into that asset’s stock price?
A lot of that is driven by interest rate, which is driven significantly by monetary policy. In turn, that may bring inflation into the conversation. I then have to determine whether inflation is transitory, or whether it's something more structural.
We've been in a very accommodative monetary policy situation that is clearly beginning to ebb. Each Federal Research meeting is giving more clues about how they’re going to start weaning off asset purchases (“tapering”). Then, they will likely raise rates several quarters after that, perhaps around the end of 2022 or early 2023.
So, I don’t ignore the larger macro trends, and the macro situation right now does mean that this is not an environment where there's an avalanche of great investable ideas. But, while I’m continuing to consider what’s going on with the market, my main focus in finding investable options remains on what individual companies are saying or doing.