This is a macro level approach to investments. In this method, a fund manager looks at the economic, social, cultural and political situation of the country to determine any themes or elements that can define the growth of certain sectors. Once a sector is determined, the fund manager then analyzes the performance of various companies in that sector and pick stocks that look promising.
For example, if the fund manager, on analysis, finds that India will have a high number of 30-40 year olds in the next 2-3 years, then the 30-40 year old market segment becomes the theme he/ she chooses to follow. The fund manager will then look at sectors which cater to this market and analyze stocks in those sectors.
Since the market is initially analyzed at a macro level and then drilled down to individual stocks, this method is known as a Top-Down investment method.
This is the opposite of Top-down investing. In this method, the fund manager looks at individual stocks based on the analysis of market performance and focuses on elements like company management, price to earnings ratios and other similar factors to determine future opportunities. This method does not go all the way up to the macro-level and is usually preferred by most investors and fund managers. This approach ensures that investments are made based on the current standing of the company and chances of good returns in the future.
Top-Down and Bottom-Up investment methods are typically deployed in tandem by the investment managers to ensure that they take informed decisions. However, understanding the fundamental difference between them can be helpful for individual investors too.