Noël Amenc, Lionel Martellini: Two competing approaches are used in practice to build portfolios: bottom-up and top-down.
Professor of Finance, EDHEC Graduate School of BusinessHead of Research, Misys Asset Management Systems
The bottom-up approach is the older and the more traditional, focusing on individual stock picking. The top-down approach gives more importance to the choice of different markets as opposed to individual security selection and, as such, emphasises the importance of asset allocation. Asset allocation consists of choosing the spread of different asset classes within the portfolio.
There two separate steps in the asset allocation process. One first defines the long-term allocation, based on estimates of risk and return for each asset class. This is known as “strategic allocation“. Then, one can subsequently carry out dynamic adjustments based on short-term anticipations. This is known as “tactical allocation“.
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