Should you invest in business cycle funds?

Business Cycle Funds, as the name suggests, are supposed to profit by timing the business cycle. This means that funds do better by buying cyclical sectors during an upswing and defensive sectors during a downswing. Another version of this category is a fund that can select companies at the right time in their life cycle (early, mid, or mature). The reality, however, does not live up to this promise. Most business cycle funds are too recent to have a significant track record, and the one with the long track record failed to beat the S&P BSE 500.

These funds are not highly concentrated in terms of stocks or sectors despite their supposed sector focus, and there is little evidence that they can make sector changes at the right time. Such funds tend to have higher expense ratios than diversified flexible-cap funds (which are generally larger), and this is likely the main reason AMCs are eager to launch them.

The oldest fund in this category is the L&T Business Cycles Fund, launched in 2014 in anticipation of an economic recovery. “The idea was to play 100% cyclical stocks and eliminate defensive ones,” Venugopal Manghat, head of equities at L&T Mutual Fund, told the Mint. The strategy was developed 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 surprising: the fund returned just 9.32%, compared to the 18.41% of the S&P BSE 500. The reason is that it never changed from cyclicals to defensives when the cycle turned.

Mangat says the fund has not moved into sectors such as consumer staples, IT and pharmaceuticals in nearly eight years of its existence as the “economic bull cycle” continues. “We don’t believe in 1-2 year slowdowns,” Mangat said. Overall, the L&T Business Cycles Fund has generated a CAGR of 11.74% (through September 9, 2022) since inception, lower than the 12.95% of the S&P EEB 500.

The other four schemes in this category are of more recent vintage. ICICI Prudential AMC launched its scheme in early 2021, a timing that proved fortuitous. The fund has returned 20.98% since launch compared to 18.49% for the S&P BSE 500 (as of September 9, 2022). The fund counts financials, energy, autos, construction and healthcare as its top five sectors. Fund manager Anish Tawakley told the Mint that the index’s overall deviation would be greater than 50% and that there could be many sectors and industries where it would have a zero weight. 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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Subsequently, in 2021, three more funds were launched under this theme: 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 it a good moment? 2021 was marked by a strong rebound from Covid-19 lows and fueled by loose monetary policy in the US and elsewhere, and this was reversed by rising inflation in 2022. Two of the three Funds have posted lackluster returns, delivering 4-5% returns since inception and failing to outperform their benchmarks. Tata Business Cycle Fund, posted a 12.10% gain 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 Offering (NFO). According to Nilesh Shah, CEO of Kotak Mahindra Asset Management Company, the fund will be able to follow the strategy that the former Kotak Select Focus Fund (now Kotak Flexi Cap) was following, building strength in high-conviction sectors. Kotak Flexi Cap is now forced to be large-cap oriented due to its size, according to Shah, which requires a new framework for this type of strategy, a gap that Kotak Business Cycle Fund can now fill. According to Shah, companies can be in the early, middle or late stage of their growth. The fund will seek to bring together a portfolio of companies at different stages of their life cycle, taking a core and satellite approach: the core trying to capture longer cycles and the satellite trying to capture shorter cycles.

Experts in the personal finance space are cautious in this category. They expect AMC’s existing diversified funds to take the business cycle into account. Therefore, a special business cycle fund may be a mere replica 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 much different from the diversified funds of the same AMCs. “Portfolios of more actively managed funds are typically expected to align with business cycles anyway, unless they are looking for a specific value, against or theme play,” said Nirav Karkera, head of Fisdom research. “L&T Business Cycle, the only fund in this category that has a track record of more than 5 years, has again performed well over the past year, but underperformed over a longer period (3 and 5 years). Looking at the limited track record, we note that, over the past year, most business cycle funds have done well with most of the outperformance coming from the industrials and consumer cyclicals sectors where these funds were significantly overweight in relative to a benchmark,” said Roopali Prabhu, CIO and co-head of products and solutions at Sanctum. Wealth.

“We believe that business cycle funds can, at best, be used as a tool to add overweight positions to favored sectors. Diversified equity mutual funds tend to reflect the industry views of the fund house over a period of time. Additionally, diversified funds have been more consistent, enjoy a much longer track record, and offer a more comprehensive set of options. Business cycle funds still need to build a track record and highlight their ability to add value to client portfolios. We prefer well-managed diversified funds with a strong track record over business cycle funds currently,” she added. Without such a track record, a business cycle fund can be akin to buying an existing fund at a higher cost.

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