Investing with a Bottom-up approach in Mutual Funds
The Bottom-up investing approach focuses on Microeconomic factors
Bottom-up investors rely strongly on fundamental analysis of stock
When we talk about investing in Mutual Funds, it is broadly categorized into bottom-up and top-down approaches. These approaches directly relate to economics and its two divisions, namely microeconomics and macroeconomics. Here is some information about this Bottom-up approach in the context of these two categories.
What are Microeconomics and Macroeconomics?
Microeconomics is the study of economics based on individual, group or business decisions. In contrast, macroeconomics is the study of the economy considering decisions made at the national level by governments.
Microeconomics focuses on allocating resources such as supply and demand and other forces that determine price levels. In addition, it considers taxes, regulations, and government legislation.
Macroeconomics aims at considering the economy as a whole, like GDP geopolitical conditions. It is an analytical tool used to formulate economic and fiscal policy.
What is Bottom-up investing?
The Bottom-up investing approach focuses on Microeconomic factors overlooking the Macroeconomic factors. Bottom-up investors focus on the fundamentals of a specific company and its growth indicators such as revenue and earnings including the products and services offered, supply and demand, financial statements, company management, price to earnings ratio, research reports, and its overall financial health analyze the individual stocks. This approach assumes that respective companies can relatively perform well even in an underperforming industry.
How does the Bottom-up Investing approach Work?
In the Bottom-up approach, investing decisions are based on choosing a company and studying its whereabouts thoroughly before investing. The strategy applied here is to be familiar with the company’s financial health and future opportunities.
The initial investment research starts at the bottom at the individual firm level, and the highest weightage is given here. This research provides an investor with a deep understanding of a single company and its stock, providing insight into an investment’s long-term growth potential. In addition, it involves understanding a company’s value from the consumer’s point of view in the real world. When they invest in such a company, they actively use and know about it from the ground level and how they become most successful. Eventually, the industry group, economic sector, market, and macroeconomic factors are brought into the overall analysis.
Bottom-up investors rely strongly on fundamental analysis of stock and follow long-term, buy-and-hold strategies focusing on long-term returns than short-term gains. Examples of a few success stories are Meta (formerly Facebook), Google, and Tesla.
When does the Bottom-up approach work well?
One should consider some basic rules while considering a bottom-up approach for investment. First, the bottom-up approach is more stock-specific. However, the bottom-up approach may not work well in times of high volatility as the focus shifts towards predominant macro risks. At the same time, mid-cap stocks are more responsive to a bottom-up approach as they operate on a unique set of economic drivers not precisely connected to the broad macroeconomic factors.
What are the advantages of Investing with a Bottom-up approach in Mutual Funds?
i) Investors become highly conversant with the company and its internal working principles before they invest; for example, investors may get attracted towards a unique marketing strategy or organizational structure that may be a reason for a bottom-up investor to invest.
ii) The thorough research helps the investors predict the company’s future growth potential.
iii) Sometimes, there may be an offer from the companies to pay a significant dividend to Bottom-up investors.
What are the disadvantages of Investing with a Bottom-up approach in Mutual Funds?
i) This investing approach sometimes becomes too risky as this is limited to a single company. In addition, completely overlooking the macroeconomic factors may be misleading and eventually lead to losses.
ii) Even in an otherwise booming industry sector, certain factors like accounting irregularities on a particular company’s financial statements may be a problem for a firm.
iii) The research to know all about the company accurately may consume much more time and can delay the proceeding with the investment.
In a nutshell, bottom-up approaches have both pros and cons. Therefore, Fund Managers often employ relative weightage that varies in cases, like when to adopt this approach and how much to rely on this approach. It’s always better to consult a financial advisor for expert vision and guidance.
That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.
With this one can say “Mutual Fund Sahi hai”, so let me do Nivesh