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Should you invest in business cycle funds?

Business Cycle Funds, as the name suggests, are supposed to benefit from timing the business cycle. This means that the funds outperform by buying cyclical sectors during an upturn and defensive sectors during a downturn. Another version of this category is a fund that can pick companies at the right time in their life-cycle (early stage, mid or mature). The reality, however, does not bear up to this promise. Most business cycle funds are of too recent vintage to have a meaningful track record, and the one that has a long record failed to beat the S&P BSE 500.

These funds are not very concentrated in terms of either stocks or sectors despite their supposed sector focus, and there is little evidence of them being able to make sectoral switches at the right time. Such funds tend to have higher expense ratios than diversified flexi-cap funds (which are generally larger) and this is likely to be the main reason why AMCs are keen to launch them.

The oldest fund in this category is L&T Business Cycles Fund, launched in 2014 on the expectation of an economic upturn. “The idea was to 100% play cyclicals and eliminate defensives,” Venugopal Manghat, head, equities at L&T Mutual Fund, told Mint. The strategy played out during the bull run of 2015 and 2017 but failed spectacularly in stagnant markets during 2018 and 2019. In calendar year 2020, its underperformance was striking. The fund delivered just 9.32%, compared to 18.41% of the S&P BSE 500. The reason, it never shifted from cyclicals to defensives when the cycle turned.

Manghat says the fund has not moved into sectors like consumer staples, IT and pharma in almost eight years of its existence since the ‘economic upcycle continues’. “We don’t believe in playing the 1-2 year kind of slowdowns,” Manghat said. Overall, L&T Business Cycles Fund has delivered a CAGR of 11.74% (till 9 Sept 2022) since inception, lower than the 12.95% of the S&P BSE 500.

The other four schemes in this category are of more recent vintage. ICICI Prudential AMC launched its scheme at the start of 2021, a timing that proved fortuitous. The fund has delivered 20.98% since launch compared to 18.49% on the S&P BSE 500 (till 9 September 2022). The fund counts financials, energy, automobile, construction and healthcare as its top five sectors. The fund’s manager, Anish Tawakley, told Mint that overall deviation from the index would be over 50% and there could be many sectors and industries where it will have nil weightage. ICICI Prudential Business Cycle Fund previously took exposure to metals but is avoiding FMCG, metals and unsecured consumer loans. According to Tawakley, the scheme was able to catch the auto sector at the bottom of its cycle.

 

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Later in 2021, three other funds under this theme were launched: Tata Business Cycles Fund, Baroda BNP Paribas Business Cycles Fund in August and September 2021, respectively, and Aditya Birla Sun Life Business Cycles Fund in December 2021. Was this good timing? 2021 was marked by a sharp rebound from the Covid-19 lows and fuelled by loose monetary policy in the US and elsewhere and this situation was reversed by the surge in inflation in 2022. Two of the three funds have posted lacklustre returns, delivering 4-5% gains since inception and failing to beat their benchmarks. Tata Business Cycle Fund, posted a gain of 12.10% since inception, almost exactly the same as the S&P BSE 500 over the same period.

Kotak Business Cycle Fund is currently in the process of its New Fund Offer (NFO). According to Nilesh Shah, CEO, Kotak Mahindra Asset Management Company, the fund will be able to follow the strategy that was being followed by the erstwhile Kotak Select Focus Fund (now Kotak Flexi Cap), going strong on high conviction sectors. Kotak Flexi Cap is now forced to be large cap-oriented because of its size, according to Shah, necessitating a new scheme for this sort of strategy, a gap that Kotak Business Cycle Fund can now fulfil. According to Shah, companies can be in the early, middle or late stage of their growth. The fund will seek to assemble a portfolio of companies at different stages in their life cycle, adopt a core and satellite approach—the core part trying to catch longer cycles, and the satellite part the shorter ones.

Experts in the personal finance space are cautious on this category. They expect the existing diversified funds of AMCs to take the business cycle into account. A special business cycle fund can thus amount to a mere replication of an existing fund, but with a higher expense ratio. A Mint analysis of the portfolios of such funds shows higher expense ratios and portfolios that are not very different from diversified funds of the same AMCs. “Most actively managed funds‘ portfolios are typically expected to anyway align with business cycles, unless it seeks a value, contra or theme-specific play,” said Nirav Karkera, head- research, Fisdom. “L&T Business cycle, the only fund in this category that has more than a 5-year track record, has again done well over the last one year but underperformed over longer tenure (3 and 5 years). Looking at the limited track record, we observe that, over the last one year, most of the business cycle funds have done well with the bulk of the outperformance coming from industrials and consumer cyclical sectors where these funds were significantly overweight relative to a benchmark,” said Roopali Prabhu, CIO and co-head, products and solutions, Sanctum Wealth.

“We think business cycle funds can, at best, be used as a tool to add overweight positions to sectors in favour. Diversified equity mutual funds tend to reflect sector views of the fund house over a period of time. Also, diversified funds have been more consistent, enjoy a much longer track record and offer a more comprehensive set of choices. Business cycle funds still need to build a track record and highlight their ability to add value to client’s portfolios. We prefer well-run diversified funds with a strong track record over business cycle funds currently,” she added. Without such a track record, a business cycle fund can amount to just buying an existing fund at a higher cost.

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