Those who wish to take the benefit of first mover advantage and do not wish to take the risks involved of investing in sectorial funds can invest in the business cycle funds.
A fund which follows business cycles will have exposure to a set of sectors which are expected to do well based on the phase of the economy, rather than any other parameter.
Like we experience cycles when it comes to weather (summer-monsoon-winter), the economy too goes through cycles. When it comes to the economy, there are four distinct phases. In the boom and recovery phase, the economy does relatively better whereas during depression and recession phase, the overall level of economic activities comes down. The journey of an economy through each of these phases is called a business cycle. The change in a cycle can be triggered due to various reasons which include factors such as interest, inflation etc.
The duration of each of these phases and that of an entire business cycle is not always the same. Therefore, one cannot easily predict when a phase will begin or end. However, there are certain indicators which can help indicate the change in the phase of a business cycle. For example: The increase in bank credit and orders for capital goods companies may point towards the onset of recovery phase while hyperinflation accompanied with higher interest rates points towards imminent reversal of the boom phase. What one needs to be mindful about is that the time period between the lead indicator and the actual change is difficult to predict.
Different phases of a business cycle can manifest in different economies at different times. So, at certain times, a particular business cycle in one economy may present business opportunities for other economies.
Why business cycle investing?
It is important to understand that sector performance varies during different phase of a business cycle. For example: Financial sector will perform better during the recovery and boom phase but defensives such as pharma and FMCG are likely to fare much better than other sectors during phases such as recession and depression. This was evident from the performance of pharma and telecom during the early phases of pandemic.
In business there is always a “first mover advantage”. So a person who pre-empts others is able to reap extra benefits as compared to those who follow the first mover. Similarly, when it comes to investing in stock markets too, it is all about identifying opportunities well in advance. Based on the lead indicators, the fund manager who understands the economy and the market can capitalise on such opportunities and help investors make gains from their investments.
Based on the economic conditions and the cycle in which one is, the fund manager decides on the sector for investment. The next step is to zero in on the robust companies. Since all the companies in a sector may not do well even during the best of the times, a fund manager is better placed to take a call due to the vast research team at his disposal. Given this approach to investing, investors can be rest assured that the portfolio build will be robust to ride the market cycle and capitalise in on the market opportunities.
How business cycle is different from sectoral/thematic investing
A fund which follows business cycles will have exposure to a set of sectors which are expected to do well based on the phase of the economy, rather than any other parameter. As a result, the portfolio will have exposure to three to five sectors and there will be diversified holdings within those sectors. In case of sectoral or thematic, the theme of investment is static which is not the case in a business cycle fund. Here, the sectors will keep rotating as per the change in business cycle.
L&T Business Cycle Fund is only one fund in existence and New Fund Offer of ICICI Prudential was on till 12th January 2020. Those who wish to take the benefit of first mover advantage and do not wish to take the risks involved of investing in sectorial funds can invest in the business cycle funds.
(The writer is a tax and investment expert, and can be reached at firstname.lastname@example.org)