Explainer: Investing Based On Business Cycle

When it comes to investing, there are various ways in which one can invest in the equity market. Over the past few years, mutual fund companies have launched funds based on business cycles. But what does the business cycle mean? A business cycle or an economic cycle refers to oscillation between periods of economic expansion and contraction. Typically, business cycle-based investing means adjusting investment strategies according to the different stages of the economic cycle.

Phases of Business Cycle

Generally, the business cycle comprises four phases - expansion, peak, contraction, and trough. The expansion phase involves a period of economic growth, increased production, and rising employment. The peak is the point where the economy reaches its highest level of activity. Employment is often at its peak, and key economic indicators are strong. However, it also signals a potential slowdown.

Then comes the contraction phase. It is also called recession and this phase marks a decline in economic activity. Production declines, unemployment rises, and consumer spending slows down. And finally, the last phase is that of trough which is also the bottom of the economic cycle. This is the period when the economic activity is at its lowest. Typically, one phase triggers the next, creating a cyclical progression of the phases.

Understanding Business Cycle-Based Offering

In the case of a business cycle fund, the fund manager aims to identify which phase the economy is in and position their portfolio accordingly. For instance, during an expansion phase, the fund manager is likely to favour cyclical sectors, while during a contraction, the portfolio may be largely positioned with defensive sectors and bonds. The goal is to capitalise on opportunities and minimise risks associated with the various economic conditions.

Given the nature of the fund, business cycle-based offerings are classified under thematic equity mutual funds. Unlike sectoral/thematic schemes which focus on specific industries, sectors or themes, business cycle funds are diversified across various sectors. This diversification helps mitigate risks associated with the performance of any single sector. However, as and when the cycle warrants, the fund manager also has the flexibility to develop concentrated portfolios as well to make the most of the opportunities available.

Most business cycle-based offerings use a combination of top-down economic analysis with detailed bottom-up stock research. The fund aims to get the sector picks right basis the economic cycle such that sizeable alpha can be generated. Currently, most of the portfolios are geared towards domestic-facing industries as investors across the globe are optimistic about the prospects of the Indian economy. This positive outlook is driven by robust corporate balance sheets, strong domestic demand, and a renewed emphasis on production-linked incentives (PLI) schemes, shaping the fund manager’s stock selection approach in response to the evolving economic scenario.

Who should invest? 

Investors with an aggressive risk appetite can consider investing in this type of fund. The caveat here is one should stay invested with a minimum investment horizon of three to five years such that the calls taken by the fund manager can play out in the meantime. There could be phases in such funds when the alpha generated is sizeable as compared to other equity-oriented offerings and vice versa.

Currently, within this theme, there are a total of 10 offerings and most of these have managed to deliver good returns for patient investors. The potential of the category can be gauged from the fact that it is a fund in the category which has managed to double the investment money over the past three years. So, when deciding to invest, fund selection matters. When selecting a fund, do consider the long-term track record and how the fund manager has responded to the changing market conditions. This will indicate if the fund manager has been successful in churning the portfolio as the economic cycle undergoes a change.

In terms of tax implication, investments in this type of scheme are taxed as equity funds. If the investment is held for one year or more, any gain will be taxed at a long-term capital gains rate of 10%, with an exemption for gains below Rs 1 lakh in the ongoing financial year. If held for less than a year, the gains will be subject to a flat rate of 15%, without any exemptions.

Disclaimer

The views are personal and are not part of the Outlook Money editorial Feature.