Top Down Can Work

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One of the things that makes managing money a lot of fun (for me anyway) is that there is always opportunity to observe and learn (same with firefighting) or confirm some things. One building block of how I manage money and what I've written about for the last eight years is top down portfolio management.

Top down places the most importance on being in or out of the market. Over the years I've seen several studies that attribute 70% of returns to being in or out. An example I used when I first started this site was in 2000 would it have been easier to simply avoid stocks or find the few stocks that somehow went up as the market was cutting in half. I think the same thing applies to late 2007.

Top down would then say that the next 20% of returns is attributable to sector and country decisions and the final and least important 10% comes from stock selection. In practice this would play out with most of the names in a particular segment performing roughly in line with each other. Of course this is not a 100% certainty and the extent to which this occurs often enough would drive whether you think top down is best for you. It is right often enough for me.

The testing that we are doing for RRGR includes our placing a lot of mock trades for the portfolio. We are placing what amounts to paper trades and submitting them to Bank of New York so that they can account for the changes in the portfolio, calculate a mock NAV and create a mock basket for the fund. Many of the trades have been swapping like for like. So while there are quite a few names in the portfolio (this is a mock portfolio remember) that we don't own the portfolio has been behaving about the same as the regular portfolio.

As I believe in top down I am probably predisposed to see it this way and again, top down either resonates with you or it doesn't. That there can be less importance on stock picking means that investors can use things like sector and country funds for their portfolio while still managing the risk they are taking and the volatility they are exposing themselves to; for people who are inclined to take it that far.

The path here may not necessarily be about trying to beat the market but more along the lines of smoothing out your own ride and being reasonably close to the market. If you save enough and stay reasonably close then you've got a good chance of having enough when you need it.

Happy 4th.