By Naveen Gogia, Executive Vice President & Co-Head – Sales & Distribution – HDFC Asset Management Co Ltd
Structural tailwinds of demand, digitisation, demography and democracy hold India in good stead. Despite various challenges, India’s GDP growth rate is expected to be higher than most large economies. India’s growth is aided by reforms, continued infrastructure investments and the unfolding of the China +1 story. Low leverage and strong fundamentals are especially helpful in a world with tighter monetary policies and significant geopolitical risk.
Across the history of markets, we have seen different sectors and businesses in multi-year upcycles at varying times. One could look at the Indian IT exports business (1999-2001), banks and capex linked businesses (2004-08), and e-commerce in the past few years. In such upcycles, they see significant expansion in sales, and leverage effects give a boost to earnings. As investors chase this growth, such sections of the market also tend to receive higher valuation multiples. While investing in business upcycles can be fruitful, one has to do it with a good understanding of the cycle and the current position, which can be a difficult proposition for a retail investor.
Solution? Business Cycle Funds
Business Cycle funds aim to invest in businesses likely on the cusp / midst of favourable business cycles. This allows you to delegate your business / sector selection task to the fund manager in a convenient and cost effective manner.
A business cycle is the journey across four phases of growth in business activities observed across time. In these four phases, we see acceleration / deceleration across business indicators. These funds would manage risk via adequate diversification across sectors / sub sectors / market cap, and an active and agile approach towards business cycle selection.
Along with a top down analysis focusing on both macro and business specific indicators, a bottom up approach for stock selection is used. When businesses are in an upcycle, investors get the dual benefit of earnings growth and improvement in valuation multiples.
A focus on avoiding businesses in downcycles, implies that the fund is likely to have lower benchmark overlap – and also leads to higher scope for alpha generation vis a vis other diversified equity mutual fund schemes, with the cost being a higher risk profile. Having diverse businesses in the same product, leads to a lower risk profile compared to most sector / thematic products, as they are higher exposure to companies in a single sector / business. For example, in the current environment, multiple businesses seem to be on the cusp of / in the midst of upcycles – such as the banking, private sector capex, real estate, Specialty chemicals, hotels and hospitals.
Investors may consider this fund as a buy and hold / SIP product, given the diverse nature of holdings and agility in rotation of investments based on assessment of stages of business cycles. As with most equity products, one must have an investment horizon of at least 3 years to consider investment.
With a multitude of information at the disposal of investors, DIY investing might be fraught with risks. Arguments for and against investments in equities can confuse investors. Investors may take a balanced approach towards equity investments, and consider investing in Business Cycle Funds!