Business cycle funds can help generate alpha by targeting sectors poised to outperform in various phases of the economy. These funds have delivered strong performance, with average one-year returns exceeding 40%, outperforming many thematic funds.
Investing in these thematic funds through systematic investment plans is a better approach because of their inherent volatility. While business cycle funds are often multi-cap or flexi-cap, they tend to focus on specific sectors that are performing well at any given time. Investors are drawn to their flexibility, allowing dynamic adjustments based on macroeconomic trends.
However, business cycle funds can be more volatile compared to traditional diversified funds. So, a higher risk tolerance is necessary. Jiral Mehta, senior research analyst, FundsIndia, says business cycle funds aim to identify growth themes through dynamic allocation across sectors and stocks at different stages of the business cycle depending on the medium and long term trends. “Those with a high risk appetite, wanting to explore sectors and thematic investing should start with a limited exposure and increase it over time,” she says.
The recent strong rallies in certain sectors have driven investor interest, making them believe they can capitalise on these cyclical opportunities. Soumya Sarkar, co-founder, Wealth Redefine, an AMFI registered mutual fund distributor, says by investing regularly through SIPs in business cycle funds, investors can take advantage of market fluctuations — buying units when the net asset value is both high and low. “This helps smooth out the average cost of investment over time, mitigating the impact of short-term market fluctuations and managing the risks associated with high volatility,” he says.
Asset management companies (AMCs) are launching business cycle funds because there is increasing demand from investors willing to take on more risk for the potential of higher returns. It also allows AMCs to provide a diversified and flexible fund option that adjusts dynamically with economic trends, enabling investors to optimise returns over the long term.
Longer investment horizon
Business cycle funds require a longer investment horizon to realise their full potential. Ideally, investors should stay invested for five years. This will allow enough time for sectors to go through various phases of the business cycle and increase the probability of higher returns. “The ideal holding period is at least 5-7 years, aligning with multiple business cycles. Allocation should be moderate within a diversified portfolio, depending on one’s risk appetite,” says Nirav Karkera, head, Research, Fisdom.
Given the high-risk nature of these funds, exposure to business cycle funds should form a smaller part of an investor’s portfolio, depending on their risk appetite and financial goals. “A cautious approach would be to allocate 10-20% of one’s equity portfolio to business cycle funds, ensuring that the rest of the portfolio remains diversified and less exposed to sectoral volatility,” says Sarkar. A more conservative investor might allocate on the lower end, while aggressive investors could lean towards the higher end, but it’s critical not to over-concentrate on such cyclical strategies.
What to keep in mind
Investors should understand that business cycle funds are high-risk, high-reward investments. Since the fund managers invest heavily in sectors or themes that are expected to perform well, there is always a chance that these themes may not play out as anticipated. If a sector underperforms, it could impact the overall returns of the fund.
Before investing in business cycle funds, investors should carefully consider several factors.
These funds are designed to capitalise on different phases of economic cycles, so understanding macroeconomic trends is essential. “Since these funds dynamically shift between sectors based on the economic phase (growth, recession, recovery), investors must ensure that the fund manager has the expertise to navigate these transitions,” says Karkera.
Investors must monitor the performance of these funds closely and stay informed about the sectors in which the fund manager is allocating investments. Understanding the underlying economic cycles and being aware of market trends is crucial when investing in these funds.