Many fund managers follow an entirely bottom-up approach without giving much weight to the macroeconomic environment in their investment decisions.
While not uncommon, especially among equity fund managers, this investment philosophy may raise questions from fund buyers, as companies do not operate in isolation.
For example, fiscal and monetary policies influence the wider economy, which, in turn, impacts companies.
Shakhista Mukhamedova, co-head of global manager research Europe at RBC Brewin Dolphin, said: “It is not sensible to ignore the macro environment, it is an additional source of information that could give you a better perspective – it’s like cycling with one eye closed, even if your bike is made by the best bicycle makers you still run the risk of riding into a tree.
“The majority of investors realise that no company operates in a vacuum and the macro environment will affect businesses, including those seen as traditionally defensive/non-cyclical.”
However, predicting the trajectory of the macro environment is, at the very least, complicated, if not impossible.
Due to the complexity of the task, David Morcher, head of collectives at Avellemy, understands why many fund managers do not give much importance to macro in their investment process.
Yet, there are a few macroeconomic considerations that he believes cannot be ignored, such as the general economic climate in the countries where a company operates or an analysis of the market sector and the competitive landscape to which a company belongs.
He added: “I would expect a bottom-up fund manager to consider the risks a corporate is exposed to and I would want to see evidence that this impacts their investment decision making, either through position sizing or within their investment thesis.
“If a manager genuinely expresses complete disregard for what is going on in the environment within which their companies are operating, then this would be a point of concern.
“However, if a manager pays due attention to external factors pertaining to their investments, yet shows no interest in forecasting or explaining the current macro environment or trends, but focuses on a company’s fundamentals, I am more sanguine.”
Meera Hearnden, investment director at Parmenion, feels more comfortable with ‘macro-agnostic’ managers, as she believes there is a place for both bottom-up and top-down strategies in a portfolio.
She explained: “As long as our fund managers stick to their beliefs and process and add value by doing what they say, then they should be afforded the flexibility to be bottom-up if they choose or adopt an approach that combines the two. We look for fund managers that can add value in different ways.
“We also look at how our funds in their respective asset classes blend together by style and market cap so that over the longer term there is no reliance on just one style of investing.
“Diversifying our portfolios in this way is what we believe will deliver consistently good risk-adjusted returns over the long term.”
While Hearnden sees merits in those different approaches, she expects more from bottom-up equity fund managers running very concentrated portfolios. She would expect them to know their business “like the back of their hand” and understand all the risks their investee companies are exposed to, such as balance sheet risk and management risk.
Another macroeconomic consideration she would demand from such fund managers is to have a clear idea of how a rise in interest rates will likely impact any of their businesses that have high levels of debt, as this could impact their earnings and profitability.
Hearnden said: “While interest rate movements would be considered a top-down factor on its own, inadvertently, this could be construed as a bottom-up consideration at an individual company level as a company’s debt and the interest on that debt is inextricably linked.”
In addition to managers running concentrated portfolios, she also highlighted that emerging market managers may “arguably” need to consider top-down factors, such as interest rates, exchange rates and geopolitics.
While a pure bottom-up approach may be acceptable for equity fund managers, Mukhamedova warned that it is a “red flag” for bond fund managers, as understanding the macro environment is crucial for them to make certain decisions.
Morcher also has higher expectations from bond fund managers when it comes to having a strong grasp of changing economic fundamentals.
He said: “I would expect them to have a view on dynamics such as central bank interest rate policy, as this will drive the attractiveness of future returns from large parts of their universe.
“With this in mind, I would expect them to regularly analyse such factors in a consistent manner to allow them to make investment decisions based on stable economic inputs.”