Index tracking is increasingly popular. The objective is simply to match the performance of a particular stock market index.
Most traditional investment companies prefer active management techniques. Two of the most common are known as top-down and bottom-up.
Top-down investment works by examining and forecasting strategic factors such as economic and industrial trends - concluding, for example, that now is a good time to invest, or not, in specific industries.
Bottom-up pays much less attention to the "big picture" and enables fund managers to select individual company shares based on performance and prospects.
Which works best? Unhappily there is no simple answer - but investors should at least understand the basics before handing over their cash. Top-Down investment, which is used by some of the larger, more general investment funds, either does away with individual share selection or restricts the manager's choice.
This approach looks at a variety of official economic statistics to determine in which markets or sectors of a stock market to invest.
Once this overall investment strategy has been decided, there are wide variations in how it is put into practice. Some groups allow the managers to decide within a limited range which companies to invest in. Others, applying top down more strictly, allow no freedom of choice, investing only in those companies that are members of the relevant index in that particular market or sector.
One such fund is the Kleinwort Benson Global Equity Trust. Launched in February 1995, it provides an investment in the world's equity markets. To ensure that it can be used in a general personal equity plan (PEP), with all its tax advantages, over half the investments are in the European Union.
"The fund employs a passive investment strategy called total asset allocation" says Simon White, Director of Kleinwort Benson Investment Management. "This allows us to pick the most attractive markets on a worldwide basis."
A variety of economic criteria from every major country are looked at. Having decided on the relative attractiveness of the individual stock markets, investment funds are allocated.
Managers have no choice in deciding which particular shares to buy. Instead, funds are invested in the shares that make up the relevant index in each market.
"We invest in the FT-SE 350 Index stocks in the UK, Eurotrack 300 for Europe, Nikkei 225 stocks in Japan, S&P 500 in USA and FTA Pacific for Far East markets" adds Mr White. "In all, this gives us over 800 individual companies to invest in."
Kleinwort argues that this technique takes the pain out of stock selection, reducing the risks. The aim of the Kleinwort fund is to capture the benefits of steady growth over the long term, five or more years, from a global portfolio of shares. Because it invests in various index stocks, it is unlikely to provide outstanding short-term performance. But like the tortoise in the race with the hare, it aims to win over the long term - outperforming its competition.
FUND managers who take the bottom-up approach use in-depth research into individual companies before deciding whether to invest in their shares.
In some investment houses this bottom-up stock selection process takes place against a background of examining global trends and forecasting movements in the world economy - but in many cases these issues are virtually ignored.
Looking after pounds 330bn on behalf of more than 10 million investors worldwide, Fidelity Investments is probably the largest example of a group using a bottom-up investment strategy. "We do not employ economists," says John Ross, portfolio strategist of the group. "We do not even talk about macro-economic factors here."
Following this method of stock selection, Fidelity believes it finds out more about the potential future of any investments by doing its own research into companies.
"We nearly always talk to companies before we invest, going to visit them. We not only talk to the senior executives, we chat to line management and go on the shop floor" adds Mr Ross. "This applies just as much to blue chip FT-SE 100 companies as to the small and medium-sized ones."
Fidelity employs 47 analysts in London, making it one of the UK's largest investment/ research houses and its visits are not one-offs. It continually monitors existing and potential investments - even with highly regarded blue chip companies that are performing well. Since 1990, for example, it has made 171 visits to BP, which has proved to be one of many successful investments made by the group.
The group's fund managers are basically looking at predicting the long- term earning power of their investments. They are monitoring their estimates and assumptions and want to know if a company is improving its market share, cutting costs, has new products in the pipeline and all the other factors that lead to long-term growth.
In other words, Fidelity wants to know how good a company is at making money and, just as important, what the management is doing to improve its performance in the future.
If a company does not meet all its criteria, Fidelity will not invest. Nor will it blindly follow a good management team. Mr Ross is fond of quoting Warren Buffet, the investment guru, that "when good management meets a bad company, the bad company often wins". Only if everything looks positive, will this give Fidelity the confidence to buy shares to add to its portfolios.Reuse content