[MUSIC] Okay, so now that we've seen what top-down and bottom-up methods is about. We have also seen that both can be combined, but you may have a preference from one versus the other. In which case, what you need to know is which one to choose. Well, it depends on two things. The first thing is market conditions. As you see from the slides basically, when the markets trend sideways and there's a lot of sector rotation, i.e., it may happen that insurance companies perform well at some given stage of the business cycle, then it's banks, then it's automobiles, then it's food, etc. So, the performing sector changes quite often. Then stock-pickers or bottom-uppers as we call them, win the race. That is, obviously, provided that they are good at picking those stocks. So, here in this case, we will be talking of a market of stocks, rather than a stock market. Here, what you need is a lot of dispersion. Across sectors, not all sectors move together. They have different returns and they are de-synchronized. Or you need a lot of differences within each sector of the individual companies. And that's where the bottom uppers will do better than the top downers. Okay. Now to the opposite. If there is no dispersion of individual stock returns within a given sector, it pays to emphasize asset allocation i.e., the most important decision, and we will see that in a minute what we mean by that, is to be right on allocating a good share of your portfolio to equities, to the risky asset. And then make the decision to get out of this risky asset and increase the non-risky, a part of your portfolio, i.e., cash and bonds or less risky case of bonds. So here the asset allocation decision matters more than the one of selecting individuals securities. The other obviously factor that you need to take into consideration when you have to consider one versus the other is basically I would say it's two different fields, right. The macro, the top-down approach entails having a macroeconomic approach, a global approach. You look at the global economy, you look at the global picture and you try to derive factors which will influence markets globally across countries. And then you take preferences on countries. The bottom-upper approach is more for someone who has a good knowledge and understanding of the corporate world. So, it's microeconomics versus macroeconomics. Ideally, and that's the idea, that of using a bank or using an asset manager is that you will find people who do the top-down and you will find people do the bottom-up. This is actually how a research department is set. When I was working at the private bank here in Geneva, I was the head of research. I was doing the macro, the global picture but I had a team of about 15 analysts who were conducting the bottom-up part for making their stocks recommendations. When we look at top-down versus bottom-up, there’s also a question of market risk. And I would say here the top-down method enables you to hedge the risk of your portfolio. And if you fear that at some points markets will tumble, basically what you will do, as I pointed out earlier, is you will shift your allocation to equities, you will reduce it. And you will increase the one to the non-risky cash or less-risky part of your portfolio parts. So here, basically you can have a view with this top-down, of managing not just the return part, but also the risk part of your portfolio. If you're focusing solely on bottom-up then it's more difficult to also have a say on managing the risk of your portfolio. You can do so if you do not have the obligation to be as we say fully invested. More often than not, if you're running an equity fund, you are constrained to be, as we say, fully invested, i.e., you cannot hold more than, say, 10% of cash. So, whether you like the market or not, you have to be in the boat, you have to remain invested. So, even if you think that the whole market is too expensive, you have to stay invested. So, that's a constraint. You can hedge the portfolio using a bottom up approach if you can use derivatives. And we'll see in another book what we mean by that, how you can hedge your portfolio by the use of options and futures and also if you can do short selling as we saw when we talked about hedge-funder ability to sell short at companies. So, that enables you also to manage the risk of your portfolio. But all in all I would say it's far easier to have say also managing the risk of your portfolio if you're using the top down approach than if you're using the bottom up. I recall, and this is the picture here I show you, of the sinking boat which may be familiar to you. I remember when I was working in this private bank and we had the analysts, it was right at the peak of the bull market in 2000 and the market started tumbling. And then the analysts come and say technology is too risky here. I think we should move into more defensive stocks like food and pharma, which are less sensitive. Obviously, they have been also less performing than all of the technology, media, and telecom stocks in the late 90s, so we have hit the peak of the market. NASDAQ more than 5,000 and then it tumbles. And so the analysts came and made new recommendations. Move out of these high performing, high octane technology, media, and telecom stocks which had been delivering staggering returns. And tilt the portfolio into more defensive buckets, like food, retail, pharma, and so forth. And I remember this partner of the bank, which once came to me and said Michel, you know, we have your analysts coming each week and making new recommendations, either sector-wise, or company-wise, it sounds to me like changing cabins in the Titanic. So what do we mean by that? Well, obviously, when you're in the Titanic, it's far better to be able to leave the boat than to be able to just change cabins within the sinking boat. [MUSIC]
