Everything You Need to Know About Business Cycle Funds

Are you looking for investment themes across India? Do you seek an opportunity to invest in future market leaders? You could invest in business cycle funds. It is a thematic equity fund that rides business cycles and follows a dynamic allocation approach across industries, sectors and market capitalisation. Let’s understand business cycle funds and how market-savvy investors earn higher returns through these funds. 

What are business cycle funds?

The economy goes through various phases such as expansion, peak, contraction and slump, which lasts for a few months or years. It helps to understand that the economy does well during a boom or expansion phase and underperforms during a recession. The movement of the economy through different phases is called a business cycle. 

Changes in interest rates or the rise or fall in inflation can trigger a business cycle. As the duration of each phase differs, many investors struggle to predict when the phase begins or ends. However, business cycle funds can earn profits as sector performance changes across phases of the business cycle.

For instance, the financials and automobile sector perform well during the expansion and boom phase. However, FMCG and the pharmaceutical industry are defensive sectors and do well during the recession phase. 

The fund managers of business cycle funds identify sectors that could turn around during the business cycle. For instance, an expansion phase is suitable for automobiles, banks, capital goods, metals and infrastructure. It is followed by picking stocks that could outperform from among these sectors. 

Why invest in business cycle funds?

You could invest in business cycle funds if you seek the first-mover advantage. Business cycle funds look to pre-empt changes in the business cycle and find the next market leaders. 

Moreover, business cycle funds may have a small exposure towards global investments, thereby helping you tap international opportunities.  

Business cycle funds invest in stocks across themes, sectors and market capitalisation. It helps you capture opportunities across the market and maximise profits over time. 

You could consider business cycle funds if you are a market-savvy investor who understands investment themes. Moreover, you can invest if you have a higher risk tolerance and understand market timing. 

Do business cycle funds invest in one sector?

Business cycle funds diversify your investment across four to five sectors. It helps to understand that these funds rotate their investments across sectors depending on the change in business cycles. However, sector funds focus on only one sector, thereby increasing concentration risk. 

Business cycle funds do not have a bias towards one sector or market capitalisation. It focuses on identifying investment opportunities and managing allocation across business cycles to generate higher returns for investors.  

What are the risks of investing in business cycle funds?

Many equity mutual fund managers follow a bottom-up strategy to pick stocks for their portfolios. However, business cycle funds follow a top-down approach to identify sectors that could turn around and then pick stocks. If the fund picks the wrong sectors, you could suffer losses even though the overall market is doing well. 

Business cycle funds are impacted by cyclical risk, which adversely affects an asset class or a company’s profits. For example, some firms struggle during an economic downturn and perform well during the recovery phase. 

The performance of business cycle funds depends on adequately identifying stages of a business cycle and portfolio allocation. It means these funds have a higher allocation towards large-cap stocks during an economic slowdown. Moreover, these funds have greater exposure towards mid-cap and small-cap stocks in an expanding economy. In a nutshell, market savvy investors with a higher risk tolerance may consider business cycle funds. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in