Asset management companies are launching business cycle funds that identify economic trends and invest in sectors and stocks at different stages of business cycles. During the phase of economic recovery, these funds invest in cyclical stocks such as midsize and small firms and growth-oriented industries. During a slowdown, they shift to defensive stocks such as larger and stable firms. These funds follow a top-down approach — first identify the sectors and the stocks within them based on macro-economic scenarios and thematic trends.
Business cycle funds take an active investing call on specific sectors and businesses based on the fund manager’s assessment of the underlying macro-economic conditions. These funds aim to identify sectors that show signs of growth in their business cycles and are likely to outperform the benchmark indices. These funds can provide investors a good opportunity to ride the economic wave by being invested in companies that are expected to take full advantage of the present environment.
Brijesh Damodaran, managing partner, BellWether Associates, says a fund manager of a business cycle fund will look to enter before the cycle typically begins or at the early stages of the cycle. “The investor is trusting the ecosystem to play out. There could be a delay in playing out of this story if the cycle does not perform. These schemes can be part of a tactical portfolio,” he says.
At present, global markets are witnessing a rise in inflation and a shift to high interest rate regime which provides tailwinds for cyclical sectors such as banks as well as other value themes over growth and quality. Rahul Singh, chief investment officer, Equities, Tata Mutual Fund, says the present inflexion point in geopolitics is also giving rise to certain structural trends like redesigning of global supply chains and loss of competitiveness for the developed economies vs. India. “This provides tailwinds for certain sectors in India especially, manufacturing, capital goods and industrials. A business cycle fund would be able to capitalise on these opportunities while enjoying the flexibility to adapt the portfolios to business cycles that have become progressively shorter,” he says.
Word of caution
The success of the scheme mostly depends on the fund manager’s ability to accurately time the entry and exit of their positions vis-à-vis the changes in the business cycle. Varun Fatehpuria, founder & CEO, Daulat, a new-age, wealth-tech firm, says investors must evaluate the fund manager’s prior investing track record. “Investors should make sure there is very little or no sectoral overlap with their existing holdings to ensure they are not being exposed to the same sectors through these funds. If they are, they are better off buying the same funds,” he says.
Investors must note that in these funds the concentration risk is high as they invest in companies belonging to a specific sector or theme which will limit investing in other sectors. Moreover, there is an element of unpredictable market cycles that could run for extended periods.
Pranit Arora, chief executive officer and co-founder, Univest, a stock investment platform, says an investor must be careful while choosing these funds as these are cyclical in nature and may perform well when the going is good and disappoint at other times. “These have not been in the market long enough to make a conclusive point about outperformance over a longer time,” he says.
Look at diversified funds
Actively-managed equity funds like flexi-cap funds essentially follow a similar unconstrained strategy of placing specific bets on companies/sectors that are positioned to perform well during the existing economic cycle. Fatehpuria says along with the fact that these funds have a longer track record and a lower expense ratio, there’s very little reason why people should jump to investing in business cycle funds. Even Damodaran says for a new investor, diversified funds typically should be the default option and business cycle funds the tactical options which can add flavour and not the go-to fund. “It’s more targeted at a seasoned investor,” he says.
Riding the wave
These funds aim to identify sectors that show signs of growth in their business cycles
Success depends on the fund manager’s ability to accurately time the entry and exit of their positions vis-à-vis changes in the business cycle
The concentration risk is high as they invest in companies belonging to a specific sector will limit investing in other sectors