What is a business cycle?
There are four distinct phases of the economy—boom, recovery, depression and recession. The journey of an economy through these phases is called a business cycle. The change in a cycle can be triggered by various factors such as interest rates and inflation.
The duration of each of these phases and that of an entire business cycle is not always the same. Therefore one cannot easily predict when a phase will begin or end. However there are certain indicators which can help predict the change in the phase of a business cycle. For example, the increase in bank credit and orders for capital goods companies may point towards onset of recovery phase while hyperinflation accompanied with higher interest rates points towards imminent reversal of boom phase. What one needs to be mindful about is that the time period between the lead indicator and the actual change is difficult to predict.
Different phases of a business cycle may manifest in different economies at different times. So, at certain times, a particular business cycle in one economy may present business opportunities for other economies.
Why business cycle investing?
Different sectors perform differently during different phase of a business cycle. For example the financial sector will perform better during the recovery and boom phase but pharma and FMCG is likely to fare much better than other sectors during phases such as recession and depression. This was evident from the performance of pharma and telecom during the early phases of pandemic.
Based on the lead indicators, the fund manager who understands the economy and the market can capitalise on such opportunities and help investors make gains from their investments.
Based on the economic conditions and the prevalent cycle, the fund manager decides on the sector for investment. The next step is to zero in on the robust companies. Since all the companies in a sector may not do well even during the best of the times, a fund manager is better placed to take a call because of the vast research team at his disposal. Given this approach to investing, investors can rest assured that the portfolio will be robust enough to ride the market cycle and capitalise on the opportunities.
How business cycle investing is different from sectoral/thematic investing
A fund which follows business cycles will have exposure to a set of sectors which are expected to do well based on the phase of the economy. As a result, the portfolio will have exposure to three to five sectors and there will be diversified holdings within those sectors. While sectoral or thematic investments are static, in business cycle funds, the sectors will keep rotating as per the change in business cycle.
For those looking to invest in a fund where the decision making is based on macros, business cycle emerges as the go-to fund. A number of funds are available in the category and the latest entry in this category is the recent New Fund Offer of ICICI Prudential Business Cycle Fund. Investors can benefit from the expertise of the top fund managers and build an equity portfolio which may be able to stand the test of time. Always contact a good mutual fund distributor for more details and better awareness.
Koshy is a mutual fund specialist.