Business cycle funds are a type of mutual fund that invests in companies and sectors based on the economic cycle. All businesses are part of the larger economy and as a country’s economy goes through different phases, various businesses also tend to do well in each phase of the economy.

Businesses in different sectors more often than not mirror the economy and it affects their stock prices. Understanding the economic cycle helps investors to make informed decisions and we will explore business cycle funds in this blog.

Different phases in business cycle

A business cycle consists of different phases and these phases are repeated every few months or years. The four phases are as follows:

Expansion phase

In this phase, the economy is growing and all businesses are doing well due to higher demand and consumption from various quarters of the society. The job market is booming, there is a steady increase in employment generated and income levels are rising. Companies are producing more and increasing recruitment. Customer confidence is high and business outlook from various promoters, CEOs, CFOs are positive. Investor confidence is also positive during this phase. Inflation is steady and the central bank keeps the interest rate low to continue the momentum.

Peak phase

The next phase after expansion is the peak phase. Here, economic growth has reached its peak and the growth plateaus. GDP, employment and production are at their highest level and there are signs of slowdown in economic growth and inflationary pressures. Central banks are looking at raising interest rates to control inflation. From here the economy is likely to enter into a contraction phase.

Contraction phase

In the contraction phase, demand drops leading to lower production by businesses. As a result, businesses lay off employees and freeze hiring. They cut costs to protect their bottomline. There is very little or no increment in salaries and wages. Businesses will decrease their capital expenditure and expansion plans. Revenue and net profits decline. Customer confidence is low and business outlook is negative. Investors turn cautious as their outlook about the economy is weak and there is an increase in market volatility.

Trough phase

A trough is the lowest point in a business cycle, where economic activity stops declining further. It is typically characterized by weak output across various sectors like agriculture, manufacturing and services. There are clearly reduced business operations and economists identify troughs using key indicators such as GDP and stock market performance. Troughs can only be identified in hindsight and they are difficult to be noticed in real time when the economy is in this phase.

Troughs differ in severity because sometimes the economy can witness brief setbacks, while others involve extended economic hardship. In this phase, big corporations do not spend and expand their business, and sales and profits fall. There will be job losses, and limited credit is extended by banks to business. The economy will have higher unemployment and unsustainable businesses are forced to close or file for bankruptcy. Despite their challenges, troughs are important after this phase, the economy will start to recover which will lead to expansion phase.

Benefits of business cycle funds

Business cycle funds focus on sectors that are likely to do well during different phases of the economic cycle and at the same time reducing exposure to sectors that might struggle. This kind of allocation helps the fund to quickly adapt to changing economic conditions, find new opportunities in well-to-do sectors and sunrise sectors and also improve overall performance.

These funds are actively managed by fund managers and the portfolio is regularly rebalanced according to different economic indicators and market trends. The fund managers closely monitor the economy and various data points to identify emerging signals and growth prospects in new companies and sectors and shift capital from one sector to another.

To reduce risk, business cycle funds diversify their investments across various sectors and asset types. This approach avoids over concentration on a single sector and similar types of companies, which results in any major drawdowns in your portfolio and the portfolio remains stable.

When the economy is not doing well, the fund tends to shift into more stable sectors like utilities or consumer staples. These sectors help the fund to survive the downturn and bad economic situation, helping to limit potential losses.

By balancing exposure between stocks from various sectors and industries, these funds create a portfolio that weather various economic climates and protect your capital.

Who can choose business cycle funds?

If you are a long-term investor and your time horizon is 5 or 7 years or more, then you are in a better position to ride the full economic cycle. You will also be protected from any short-term volatility if you stay invested for a longer time. These funds are better suited for investors who are comfortable with market swings and willing to adjust their portfolios regularly.

Business cycle funds can help investors with their financial objectives as they focus on various sectors that tend to do better during different phases of the economy. Experienced investors who understand how markets and sectors behave during different cycles can invest through these funds to create wealth.

Conclusion

Business cycle funds offer investors a smart and flexible way to tap the Indian stock market by allocating capital across various sectors based on the economic cycle. These funds adjust their focus depending on whether the economy is expanding or contracting or recovering, which can help lower risk and optimize returns. Having said that, investors should carefully assess the fund manager’s track record, check the expense ratio and should have the risk appetite to select business cycle funds. Investing in these funds can help the investors to have an overall well-balanced portfolio.