How Business Cycle Funds Help You Ride Economic Waves

For successful investing, one needs to have the right combination of asset classes and timing. One investment strategy that can take care of these factors is business cycle investing – aligning investment decisions with phases of the economic cycle. 

What is a Business Cycle?
An economy goes through different phases or ebb and flow defined by periods of:
a) Growth – high demand and inflation, strong GDP growth, strong credit off-take
b) Recession – sticky inflation, low demand, moderate GDP growth, tighter credit conditions
c) Slump – low inflation, low GDP growth, muted credit growth
d) Recovery – pick-up in growth, inflation and demand The time taken by the economy to go through these four phases is called a business cycle. 

What is Business Cycle Investing?
Business cycle investing works by anticipating a business cycle beforehand based on market conditions and deploying a sector rotation strategy as time progresses and the economy moves through different phases. It is like a game of chess wherein the opponent’s future moves are anticipated in advance and then the game is played. Business cycle investing generally involves a topdown investment approach. It focuses more on economic indicators, future earnings potential, etc., rather than historical track records. 

How do sectors behave across business cycle phases? What is sector rotation strategy?
Different sectors perform during the four phases of the business cycle. Sectors such as pharma and IT tend to perform well during recession and slump. Sectors such as financials and auto tend to perform well during recovery or expansion phase. Hence, in each phase, there will be sectors that may outperform others and there will be sectors that may underperform. Sector rotation strategy means changing the portfolio positioning to sectors that are expected to perform in a particular business cycle phase. 

Parameters for identifying business cycles
Multiple parameters are used for identifying business cycle phase – 

• Macro indicators – Current Account Deficit, Growth, Inflation, Credit Growth, Bond Yields, etc.
• Investment indicators – Capex, project pipeline, etc.
• Business and consumer sentiment – Discretionary expenditure, business confidence, etc.
• Global indicators – Growth and policy stance, inflation, etc. It is essential that these parameters are read correctly, analysed and then a conclusion is drawn. A wrong read can lead to missed opportunities or potential losses. 
  
  How can an investor go about business cycle investing?

Mutual fund schemes offer a good platform to investors wanting to try out business cycle investing. There are funds that actively deploy the strategy and dynamically change portfolios based on prevailing business/economic cycle. Business cycle funds also have the advantage of being managed by highly experienced fund managers who have the expertise to study different parameters, gauge cycles and construct a dynamic portfolio. Since these funds generally deploy a top-down investment approach, they can turn defensive as well as aggressive quickly based on market movements. 

Characteristics of business cycle funds

• Business cycle funds are sector agnostic and can move across sectors/themes/market cap.
• Business cycles continue for months or years depending on economic conditions. Hence, in the short term, these funds can underperform.
• However, in the long run, upon completion of a business cycle phase, investors can see its wealth creation potential.
• Having the ability to position its portfolio dynamically, business cycle funds can turn defensive during market falls thereby managing volatility. 
• This strategy is best suited for seasoned investors who have spent considerable time in the market and have a good risk appetite. 
  
  Business Cycle Investing in today’s world

Situations are more complex currently than in the past decade. What was an era of easy money, low debt, stable geo-politics is now being replaced by tighter liquidity conditions, high country debt and intense geo-political disturbances. The latest one being tariff war by developed economies that are re-defining global trade order. Amidst these constantly evolving conditions, business cycle phases are changing rapidly. In order to minimise its impact on investment portfolio, an investor should consider adding business cycle funds to his/her portfolio. With their nimble and opportunistic approach, business cycle funds can help in generating superior returns over the long term.