Course Title Bond and Equity Portfolio Management

Strategies (MFB511)
Program MSc in Finance and Banking

Surname Chinhoro

First Name Milton Tendai

Reg Number R199952X

Question Compare and contrast the fundamental analysis

approach and technical analysis approach with
references to Bond and Equity Fund
Management in particular and portfolio
management in general.

Due Date: 29 May 2021

Lecturer Mr. Petros Jecheche

Introduction
Knaap (2008) asserts that in the world of investing and trading, in order to have a definite
advantage and constantly create profit, a portfolio manager must pursue a deliberate strategic
approach. Generally speaking, the two main schools of thought and strategies in bond and
equity portfolio management in relation to financial markets are fundamental and technical
analysis. Fundamental and technical analysis differ in several aspects, such as the way of
functioning and execution, the time horizon used, the tools used and their objective. These
differences lead to certain advantages and disadvantages of each of the analyses.
Fundamental and technical analysis are also a subject of critical reviews by the academic and
scientific community and many of these reviews concern the methods of their application, i.e.
the possibility of combining the two analyses and using them complementarily to fully utilize
their strengths and advantages. Fundamental analysis is used to calculate the true intrinsic
value of a share and to find opportunities where that share value differs from its current
market price. In order to do this, fundamental analysis looks at economic factors, known as
fundamentals. These fundamentals are mainly found in the company’s financial reports, as
well as reports about various macro-economic indicators and variables. Fundamental analysis
is based on the assumption that there is a time delay in the affecting of financial security
prices by these fundamentals. Technical analysis is used to predict the future market price of
a share using statistics on the past performance of that share. Technical analysis takes into
account the past changes in the price of a share and attempts to predict its future price
movements and changes. Technical analysis is based on the assumption that patterns in a
security’s price movements repeat themselves and can determine the best times for you to
buy and sell.
Definition of Key Terms

Strategy is an action that managers take to attain one or more of the organization’s goals.
Strategy can also be defined as “A general direction set for the company and its various
components to achieve a desired state in the future. Strategy results from the detailed
strategic planning process”. Reilly & Brown (2003).

Portfolio Management: is the selection, prioritisation and control of an organisation's

programmes and projects, in line with its strategic objectives and capacity to deliver. The
goal is to balance the implementation of change initiatives and the maintenance of business-
as-usual, while optimising return on investment.
Technical Analysis is the study of historical market data, including price and volume. Using
insights from market psychology, behavioral economics, and quantitative analysis, technical
analysts aim to use past performance to predict future market behavior. The two most
common forms of technical analysis are chart patterns and technical (statistical) indicators.
(Petrasek 2012).

Fundamental Analysis is a method of determining a stock's real or "fair market" value.

Fundamental analysts search for stocks that are currently trading at prices that are higher or
lower than their real value. If the fair market value is higher than the market price, the stock
is deemed to be undervalued and a buy recommendation is given (Fabozzi, 2000).

Fundamental Analysis
Fundamental analysis is a method of measuring a security's intrinsic value by examining
related economic and financial factors. Fundamental portfolio managers study anything that
can affect the security's value, from macroeconomic factors such as the state of the economy
and industry conditions to microeconomic factors like the effectiveness of the company's
management. The end goal is to arrive at a number that an investor can compare with a
security's current price in order to see whether the security is undervalued or overvalued. This
method of stock analysis is considered to be in contrast to technical analysis, which forecasts
the direction of prices through an analysis of historical market data such as price and volume.
Fundamental analysis is a method of determining a stock's real or "fair market" value.
Fundamental portfolio managers search for stocks that are currently trading at prices that are
higher or lower than their real value. If the fair market value is higher than the market price,
the stock is deemed to be undervalued and a buy recommendation is given.

All stock analysis tries to determine whether a security is correctly valued within the broader
market. Fundamental analysis is usually done from a macro to micro perspective in order to
identify securities that are not correctly priced by the market. Portfolio managers typically
study, in order, the overall state of the economy and then the strength of the specific industry
before concentrating on individual company performance to arrive at a fair market value for
the stockFor example, an investor can perform fundamental analysis on a bond's value by
looking at economic factors such as interest rates and the overall state of the economy, then
studying information about the bond issuer, such as potential changes in its credit rating. For
stocks, fundamental analysis uses revenues, earnings, future growth, return on equity,
profit margins, and other data to determine a company's underlying value and potential for
future growth. All of this data is available in a company's financial statements (more on that
below). Fundamental analysis is used most often for stocks, but it is useful for evaluating any
security, from a bond to a derivative. If you consider the fundamentals, from the broader
economy to the company details, you are doing fundamental analysis.

Technical Analysis
Technical analysis is a trading discipline employed to evaluate investments and identify
trading opportunities by analyzing statistical trends gathered from trading activity, such as
price movement and volume. Technical analysis is a trading discipline employed to
evaluate investments and identify trading opportunities in price trends and patterns seen on
charts. Technical portfolio managers believe past trading activity and price changes of a
security can be valuable indicators of the security's future price movements. Technical
analysis may be contrasted with fundamental analysis, which focuses on a company's
financials rather than historical price patterns or stock trends. Unlike fundamental analysis,
which attempts to evaluate a security's value based on business results such as sales and
earnings, technical analysis focuses on the study of price and volume. Technical analysis
tools are used to scrutinize the ways supply and demand for a security will affect changes in
price, volume and implied volatility. Technical analysis is often used to generate short-term
trading signals from various charting tools, but can also help improve the evaluation of a
security's strength or weakness relative to the broader market or one of its sectors. This
information helps portfolio managers improve their overall valuation estimate. Technical
analysis can be used on any security with historical trading data. This includes
stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial,
we’ll usually analyse stocks in our examples, but keep in mind that these concepts can be
applied to any type of security. In fact, technical analysis is far more prevalent in
commodities and forex markets where traders focus on short-term price movements.

Technical analysis as we know it today was first introduced by Charles Dow and the Dow
Theory in the late 1800s. Several noteworthy researchers including William P. Hamilton,
Robert Rhea, Edson Gould, and John Magee further contributed to Dow Theory concepts
helping to form its basis. In modern day, technical analysis has evolved to included hundreds
of patterns and signals developed through years of research. Technical analysis operates from
the assumption that past trading activity and price changes of a security can be valuable
indicators of the security's future price movements when paired with appropriate investing or
trading rules. Professional portfolio managers often use technical analysis in conjunction with
other forms of research. Retail traders may make decisions based solely on the price charts of
a security and similar statistics, but practicing equity portfolio managers rarely limit their
research to fundamental or technical analysis alone.

Technical analysis attempts to forecast the price movement of virtually any tradable
instrument that is generally subject to forces of supply and demand, including stocks, bonds,
futures and currency pairs. In fact, some view technical analysis as simply the study of supply
and demand forces as reflected in the market price movements of a security. Technical
analysis most commonly applies to price changes, but some portfolio managers track
numbers other than just price, such as trading volume or open interest figures. Across the
industry there are hundreds of patterns and signals that have been developed by researchers to
support technical analysis trading. Technical portfolio managers have also developed
numerous types of trading systems to help them forecast and trade on price movements.
Some indicators are focused primarily on identifying the current market trend, including
support and resistance areas, while others are focused on determining the strength of a trend
and the likelihood of its continuation. Commonly used technical indicators and charting
patterns include trend lines, channels, moving averages and momentum indicators. In general,
technical portfolio managers look at the following broad types of indicators:

 Price trends
 Chart patterns
 Volume and momentum indicators
 Oscillators
 Moving averages
 Support and resistance levels

Underlying Assumptions of Technical Analysis

There are two primary methods used to analyze securities and make investment
decisions: fundamental analysis and technical analysis. Fundamental analysis involves
analyzing a company’s financial statements to determine the fair value of the business, while
technical analysis assumes that a security's price already reflects all publicly-available
information and instead focuses on the statistical analysis of price movements. Technical
analysis attempts to understand the market sentiment behind price trends by looking for
patterns and trends rather than analyzing a security's fundamental attributes. Charles Dow
released a series of editorials discussing technical analysis theory. His writings included two
basic assumptions that have continued to form the framework for technical analysis trading.

1. Markets are efficient with values representing factors that influence a security's price.
2. Even random market price movements appear to move in identifiable patterns and
trends that tend to repeat over time.

Today the field of technical analysis builds on Dow's work. Professional portfolio managers
typically accept three general assumptions for the discipline:

1. The market discounts everything: Technical portfolio managers believe that

everything from a company's fundamentals to broad market factors to market
psychology are already priced into the stock. This point of view is congruent with
the Efficient Markets Hypothesis (EMH) which assumes a similar conclusion about
prices. The only thing remaining is the analysis of price movements, which technical
portfolio managers view as the product of supply and demand for a particular stock in
the market.
2. Price moves in trends: Technical portfolio managers expect that prices, even in
random market movements, will exhibit trends regardless of the time frame being
observed. In other words, a stock price is more likely to continue a past trend than
move erratically. Most technical trading strategies are based on this assumption.
3. History tends to repeat itself: Technical portfolio managers believe that history tends
to repeat itself. The repetitive nature of price movements is often attributed to market
psychology, which tends to be very predictable based on emotions like fear or
excitement. Technical analysis uses chart patterns to analyze these emotions and
subsequent market movements to understand trends. While many forms of technical
analysis have been used for more than 100 years, they are still believed to be relevant
because they illustrate patterns in price movements that often repeat themselves.

Technical Analysis Vs. Fundamental Analysis

Fundamental analysis and technical analysis, the major schools of thought when it comes to
approaching the markets, are at opposite ends of the spectrum. Both methods are used for
researching and forecasting future trends in stock prices, and like any investment strategy or
philosophy, both have their advocates and adversaries. Fundamental analysis is a method of
evaluating securities by attempting to measure the intrinsic value of a stock. Fundamental
portfolio managers study everything from the overall economy and industry conditions.
condition and management of companies. Earnings, expenses, assets and liabilities are all
important characteristics to fundamental portfolio managers. Technical analysis differs from
fundamental analysis in that the stock's price and volume are the only inputs. The core
assumption is that all known fundamentals are factored into price; thus, there is no need to
pay close attention to them. Technical portfolio managers do not attempt to measure a
security's intrinsic value, but instead use stock charts to identify patterns and trends
that suggest what a stock will do in the future.

Limitations Of Technical Analysis

Some portfolio managers and academic researchers expect that the EMH demonstrates why
they shouldn't expect any actionable information to be contained in historical price and
volume data. However, by the same reasoning, neither should business fundamentals provide
any actionable information. These points of view are known as the weak form and semi-
strong form of the EMH. Another criticism of technical analysis is that history does not
repeat itself exactly, so price pattern study is of dubious importance and can be ignored.
Prices seem to be better modelled by assuming a random walk. A third criticism of technical
analysis is that it works in some cases but only because it constitutes a self-fulfilling
prophesy.

Quantitative and Qualitative Fundamental Analysis

The problem with defining the word fundamentals is that it can cover anything related to the
economic well-being of a company. They obviously include numbers like revenue and profit,
but they can also include anything from a company's market share to the quality of its
management. The various fundamental factors can be grouped into two categories:
quantitative and qualitative. Quantitative – "related to information that can be shown in
numbers and amounts." Qualitative – "relating to the nature or standard of something, rather
than to its quantity." In this context, quantitative fundamentals are hard numbers. They are
the measurable characteristics of a business. That's why the biggest source of quantitative
data is financial statements. Revenue, profit, assets, and more can be measured with great
precision. The qualitative fundamentals are less tangible. They might include the quality of a
company's key executives, its brand-name recognition, patents, and proprietary technology.
Neither qualitative nor quantitative analysis is inherently better. Many portfolio managers
consider them together.

There are four key fundamentals that portfolio managers always consider when regarding a
company. All are qualitative rather than quantitative. They include:

 The business model: What exactly does the company do? This isn't as
straightforward as it seems. If a company's business model is based on selling fast-
food chicken, is it making its money that way? Or is it just coasting on royalty and
franchise fees?
 Competitive advantage: A company's long-term success is driven largely by its
ability to maintain a competitive advantage—and keep it. Powerful competitive
advantages, such as Coca-Cola's brand name and Microsoft's domination of the
personal computer operating system, create a moat around a business allowing it to
keep competitors at bay and enjoy growth and profits. When a company can achieve a
competitive advantage, its shareholders can be well rewarded for decades.
 Management: Some believe that management is the most important criterion for
investing in a company. It makes sense: Even the best business model is doomed if
the leaders of the company fail to properly execute the plan. While it's hard for retail
investors to meet and truly evaluate managers, you can look at the corporate website
and check the resumes of the top brass and the board members. How well did they
perform in prior jobs? Have they been unloading a lot of their stock shares lately?
 Corporate Governance: Corporate governance describes the policies in place within
an organization denoting the relationships and responsibilities between management,
directors, and stakeholders. These policies are defined and determined in the company
charter and its bylaws, along with corporate laws and regulations. You want to do
business with a company that is run ethically, fairly, transparently, and efficiently.
Particularly note whether management respects shareholder rights and shareholder
interests. Make sure their communications to shareholders are transparent, clear, and
understandable. If you don't get it, it's probably because they don't want you to.

The Concept of Intrinsic Value

One of the primary assumptions of fundamental analysis is that the current price from the
stock market often does not fully reflect the value of the company supported by the publicly
available data. A second assumption is that the value reflected from the company's
fundamental data is more likely to be closer to the true value of the stock. Portfolio managers
often refer to this hypothetical true value as the intrinsic value. However, it should be noted
that this usage of the phrase intrinsic value means something different in stock valuation than
what it means in other contexts such as options trading. Option pricing uses a standard
calculation for intrinsic value; however, portfolio managers use various complex models to
arrive at their intrinsic value for a stock. There is not a single, generally accepted formula for
arriving at the intrinsic value of a stock. This leads to a third major assumption of
fundamental analysis: In the long run, the stock market will reflect the fundamentals. The
problem is, nobody knows how long "the long run" really is. It could be days or years. This is
what fundamental analysis is all about. By focusing on a particular business, an investor can
estimate the intrinsic value of a firm and find opportunities to buy at a discount. The
investment will pay off when the market catches up to the fundamentals.

Top-down vs. Bottom-up Fundamental Analysis

Fundamental analysis can be either top-down or bottom-up. An investor who follows the top-
down approach starts the analysis with the consideration of the health of the overall economy.
By analyzing various macroeconomic factors such as interest rates, inflation, and GDP levels,
an investor tries to determine the overall direction of the economy and identifies the
industries and sectors of the economy offering the best investment opportunities. Afterward,
the investor assesses specific prospects and potential opportunities within the identified
industries and sectors. Finally, they analyze and select individual stocks within the most
promising industries.

 Figure 1. Top-down approach

 

 Alternatively, there is the bottom-up approach. Instead of starting the analysis from the
larger scale, the bottom-up approach immediately dives into the analysis of individual stocks.
The rationale of investors who follow the bottom-up approach is that individual stocks may
perform much better than the overall industry. The bottom-up approach is primarily
concentrated on various microeconomic factors such as a company’s earnings and financial
metrics. Portfolio managers who use such an approach develop a thorough assessment of
each company to gain a better understanding of its operations.

 
 Differences between the fundamental and Technical analysis

The way of working Fundamental analysis attempts to calculate the future value of a share
through various economic variables, known as fundamentals. The analysis consists of
studying the economy as a whole, the industry in which the company operates and the
company itself. The basic premise of this analysis is that in the short term, the share price
does not correspond to its value, but in the long run it will correct itself. You can make a
profit by buying shares at a lower price than their true value or by selling shares at a higher
price that their actual value. The main task of fundamental analysis is to determine the true
value of a share. Whoever performs the analysis should consider the overall performance of
the company and its financial statements, including all the latest news about the company.
Based on all that, he should conclude whether the market properly evaluated all the
information into the share price. The investor needs to consider all parts of financial
statements, including profits, assets, revenues and expenses, make a comparative analysis by
year, make a comparative analysis by certain industry standards, notice certain trends in their
behaviour and based on all that, make proper valuation of the shares. After all, stock prices
are inevitably dependent on all these numbers and only through their analysis, the investor
can understand how prices react to certain changes in the company’s financial performance.
Technical analysis is based on the premise that all the important fundamental factors are
already reflected in the share price. Accordingly, it focuses only on the share price and
trading volume, which are measured and presented at various tables and graphs. By analyzing
these graphs, the investor can obtain information about certain trend formations and
regularities in the price movement, the trading volume and their inter dependence. One of the
more popular charting tools is the candlestick chart, named because it resembles a candle.
The figure for each trading period is plotted to show the high and low prices for the period,
along with the opening and closing prices. The most common types of price patterns are:
“head and shoulders”, which shows that after its formation, the price will start moving in the
opposite direction of the previous trend, “cup and handle”, a pattern
Technical analysis also uses moving averages. They level the short-term price fluctuations
and also help in the detection of ascending and descending trends. Levels of support and
resistance are another aspect that can be analyzed by moving averages. For example, if a
share is in a downward trend, when it reaches the level of support of a long-term moving
average, it will probably change its direction. These differences are due to the basic principle
in which fundamental portfolio managers believe, which is that the shares are not correctly
valued by the market at any given moment. Technical portfolio managers consider all
external factors instantly reflected into the share price, as opposed to fundamental portfolio
managers, who believe that it takes some time for it to happen. Therefore, there is an
opportunity to make profits in the time when the price has still not reflected every available
company-related information in it. The nature and methods of the technical analysis make it
useful for short term trading and therefore, it is used mostly for trading purposes, while
fundamental analysis, on the other hand, is mainly used for investments.

Time horizon Fundamental analysis

It uses longer periods when analysing stocks than technical analysis. Technical analysis uses
relatively short periods, that may be days, weeks or months, while fundamental analysis uses
periods of several years.3 Therefore, that implies that the fundamental analysis is used by
investors who are trying to pick stocks whose value will increase in the future, over several
years. They believe that if they have chosen the correct stocks, their price will eventually rise,
even if it takes several years for that to happen.

Charts vs. Financial statements

Fundamental portfolio managers have the financial statements as the main source of
information, while technical portfolio managers use charts with price movements as the
almost only source of data. The fundamental portfolio manager estimates the intrinsic value
of the stock by analyzing the income statements, balance sheets and the statements of cash
flow. In this approach, the investment decision logic is simple – if the stock trades at a price
lower than its estimated intrinsic value, than it’s a good investment. Fundamental portfolio
managers use however more complex information in their analysis, not only the data found in
the financial statements. On the other hand, technical portfolio managers believe that all you
need to know about a stock can be found within the stock price’s charts.

Trading vs. Investing

The time difference between fundamental and technical analysis is seen not only in their
short-term or long-term approach, but also in their purpose. In general, the purpose of the
technical analysis is trading, and the goal of fundamental analysis is investment. Fundamental
analysis is primarily used by investors who buy and hold stocks for a period of time, while
technical analysis is most frequently used by traders looking to make short-term profits.
Investors buy certain stocks because they believe that their value will increase in the future,
while traders buy certain stocks because they think they will be able to sell them at a higher
price in a relatively short period of time. Sometimes, this difference may not be so clear, but
there is certainly a distinct approach between these philosophies. They certainly seem similar
and generally use the same idea and concept, but they are essentially different schools of
thought.
Advantages and disadvantages of the fundamental and technical analysis of stocks
The first advantage of fundamental analysis is that it examines real economic and market
factors in assessing the value of stocks. With fundamental analysis, you seek to understand
trends in the economy, business sectors and companies to determine if stocks are priced fairly
given the prevailing economic conditions. You begin your analysis by examining the
economic outlook to determine which industry groups are likely to benefit. Understanding the
group is as important as picking the industry leaders – the top firms in a stagnant or declining
industry are not going to be wise picks. The analysis concludes with studying the leaders in
the rising industries, looking at key statistics, management and the business plans.
Criticism toward the fundamental and technical analysis Some critics see technical analysis
as a form of black magic. In fact, technical analysis has only recently begun to enjoy some
mainstream credibility. Most of the criticism towards technical analysis derives from the
economic theory, i.e. the efficient market hypothesis. According to this hypothesis, the
current market price of a particular share is always the accurate price because it has already
calculated in it all the information available that may have influenced the share, hence,
questioning any analysis that claims to have found undervalued stocks in the market. There
are three levels of this theory. The weak-form efficiency assumes that all historic price
movements are already reflected in the share price, hence the analysis of such price
movements can’t lead to predictions for the future price patterns. However, it remains
possible that through fundamental analysis you can find certain fundamental factors, that
could influence the future share price. The semi-strong efficiency reduces the contribution
that fundamental analysis can have in selecting stocks for investing. The strong form
efficiency states that all the existing market information in connection with the share and with
the company is already taken into account and therefore, neither technical nor fundamental
analysis can help you find and detect favorable investment opportunities. Many academics
believe in some version of the efficient market hypothesis, therefore, questioning the
credibility of both the technical and fundamental analysis.

Combined use of the fundamental and technical analysis

Technical and fundamental analysis are seen as total opposites in the world of investments.
However, many investors and traders have managed to combine them and achieve successful
results. Investors who apply mainly fundamental analysis, can use technical analysis to
determine the exact time when to make a transaction, whether it’s buying or selling. Since
technical analysis is primarily a market timing tool, it can be implemented effectively in
conjunction with fundamental analysis. The proper assessment of the time to enter into the
investment opportunity can sometimes be more important and the investment itself.
Therefore, the best advice would be to study the fundamental factors, make the investment
decision and use the technical analysis to determine the time of purchase or sale. On the other
hand, investors who use mainly technical analysis, in some cases can benefit from
fundamental analysis. If a technical portfolio manager detects certain price pattern and
determine that some particular stock is a good investment, he can further confirm his
assessment by analyzing some important fundamentals of the company, which can provide
valuable information about its financial position and its capacity. This suggests that the
fundamental and technical analysis differ between each other, but they are not necessarily
mutually contradictory. In general, the proponents of both technical and fundamental analysis
are not big advocates of the idea of combining them. However, it is undeniable that there are
certain advantages in combining them or at least having a deeper knowledge of both types of
investment strategies, since technical and fundamental analysis are the most important and
the most powerful tools in the realm of finance and investing.
Conclusion
We have seen that the fundamental and technical analysis are different in many aspects,
starting from the assumptions on which they are based, to the methods used and the function
they have. These differences show that the fundamental and technical analysis are essentially
different strategies for making investment decisions. However, the observed differences don’t
necessarily indicate that fundamental and technical analysis lead to different investment
decisions. In fact, both analyses have their advantages and disadvantages that can be
combined to give optimum results. In fact, both analyses have their advantages and
disadvantages that can be combined to give optimum results.

REFERENCES
Knapp,S.P.V. (2008): Sensible stock investing: How to pick, value and manage stocks,
iUniverse

Kumar,R. (2014): How technical and fundamental analysis can help your trading decisions,
RKSV

Schabacker,R.W., Mack, D. (2005):Technical analysis and stock market profits: A course in

forecasting, Harriman House

Warneryd,K.E. (2002): Stock market psychology: How people value and trade stocks,
Edward Elgar Publishers.

Fundamental analysis versus technical analysis, from www.diffen.com

B&R Beurs: www.bnrbeurs.nl [7] PCM Brokers: www.pcmbrokers.com