Fixed Income Attribution : TopDown vs Bottom Up Approach

CFA Level III Portfolio Management
#1

Hi courageous gladiators at Dday -3,

An investment firm manages a broadly diversified portfolio of global investment-grade and high yield corporate bonds for its clients. The Fixed Income team consists of a portfolio manager and three credit analysts who review and manage the portfolio. The portfolio manager uses a top-down approach while the credit analysts use a bottom-up methodology.

We are in Fixed Income Attribution and they are asking to contrast Top-Down vs Bottom-Up Approach and came up with this answer concerning Bottom-Up :

The bottom-up approach used by the credit analysts focuses on company-specific fundamentals such as ratings, revenues, earnings, cash flows, and new product developments. The bottom-up approach searches for undervalued securities and is sector neutral.

I am confused, how are they sector neutral ?

Isn’t Sector/Quality Effect the added value the manager would derive at his micro level from overweighing or underweighting a sector vs the benchmark ?

Or are we saying we are at the Micro Level (and I misread by thinking there was a Macro Level using Top-Down and a Micro Level using Bottom-Up) and that in this team they have one side in charge of determining normal weights to sectors but still at the Micro Level (using Top-Down approach) and the other team using Bottom-Up to pick undervalued securities but being neutral to the sector ? Sounds like it could be that.

I am scared I am mixing things up with Top-Down approach at the sponsors level (Macro Attribution) and Bottom-Up approach at the Fixed Income Portfolio Manager (Micro Attribution), which isn’t great 3 days before D-Day …

Thanks

#2

In top-down, you look at macro trends in the economy, so you establish which sectors are going to over and under-perform - e.g. if the economy is in a downturn, you might think that bonds of pharma companies will do better than consumer discretionary, so you will overweight pharma as a sector.

In bottom-up, you are looking for undervalued securities based on the underlying companies’ revenues, profits, cash-flow, new products, etc., so you are agnostic (=you don’t care = are neutral) about their sector - you just want to figure out which bonds are undervalued.

#3

Thanks. I think I was just reading the question really really wrong, like from a Sponsor Macro Level vs Fund Manager Micro Level, looking at it like a Macro Attribution vs Micro Attribution question, where it was only about Top-Down vs Bottom-Up, which was occurring at the Fund Manager level. No wonder I couldn’t find a post about it, it was just pure confusion.

I don’t know why I got those 2 readings mixed up in my head, but it took me a while to realize it …

Blurry mind right before exam day, I don’t like that !

Good luck for Saturday