Managed Fund Survey: Uppers and downers

Tony Lyons examines the two principal approaches employed in fund management

Imagine you are a fund manager. You walk into the office at the start of the day knowing you have a pile of investment decisions to make. Foremost among these are what to buy, to sell and to hold on to.

You could start by taking a view on the state of the economy and its direction. From this, you could then try to work out which sectors are the gainers, which are the losers, finally arriving at a list of companies that will benefit and those that won't.

Alternatively, you could start by looking at the number of company reports done either by your own analysts or from stockbroking firms. While not totally ignoring macro economic factors, you will be more interested in the prospects for these companies, whether they have the potential for lots of future growth and increased dividends, or not.

These are the two principal methods of starting your investment strategy. The former is called "top down", the latter "bottom up". While every fund manager and management group uses elements of both, they all fall into one camp or the other.

"We are very much a bottom up investment house," says John Ross of Fidelity, the world's largest fund management group. "We have a fundamental company- by-company approach. We never try to predict interest rates or the way the economy is going, even though we know the effect these have.

"We will get a good idea of what the real economy is doing from all the companies we see."

The group employs over 200 analysts around the world, with nearly a quarter of them based in the UK. They are divided into groups that look at particular sectors, namely financials, natural resources, utilities, cyclicals, consumer goods, healthcare and technology.

"The analysts will visit as many companies, large and small, as they can in their sector," explains John Ross. "From their research, they will rate their attractiveness as an investment for our funds. It is then up to the individual fund manager."

Now contrast this approach with that of Credit Suisse, a typical "top down" fund management house. "We are very driven by macro-economics," says Dominic Wallington. "We start by taking an overview of the economy. We then see who's swimming with the tide and who against. This tells us which companies are likely to benefit in the prevailing environment. This is our basic strategy."

It is often stated that when dealing with small companies, a bottom up approach is needed. But Credit Suisse, which has earned a good reputation for its specialist funds in this sector, still uses macro-economic tools. "We know that small companies lack liquidity, [they suffer from low demand, so their shares tend to suffer from too few buyers]," adds Mr Wallington, "so we look to those which add value."

Many groups adopt a top down approach when it comes to international investment. RCM Dresdner's Global Growth fund used to be a typical example. This divided the world into segments based on each individual country's share of the global economy. From here it then selected sectors that would benefit from the then current trends before choosing which companies to invest in.

"We've now taken a more balanced approach," says Simon White. "With the changes we've seen in world markets over the past couple of years, we have moved to more stock selection, whichever county they happen to be in. If you want to invest in mobile phones, for example, you must look at Nokia. This is a Finnish company, yet Finland only has a tiny role on the world stage." So an investment in a company like this would be larger than an investment in Finland would justify on a pure top down approach.

Of course, most groups employ both approaches to some extent before making their eventual share selection. "No fund group these days will ever admit to being just a pure stock picker," says Bob Yerbury of Perpetual. "We all take into account the general economic background while we look for undervalued companies.

At the end of the day, there is surprisingly little difference in the overall performance results of the top downers and the bottom uppers. No matter where they start, be it with macro economics or looking at individual companies, the real difference is between those who make good investments and those who don't.