Business Cycle Investing: Why it Matters?

Just like a flower needs a particular season to blossom and bloom, in the markets too, there are periods in which the companies grow and generate noteworthy profits. In the world of finance, these periods are called “Business Cycles”. There are four phases of a business cycle—growth, recession, slump and recovery—different businesses are impacted in different ways. Some businesses manage to weather the tough times, whereas some of them get impacted in a weak business cycle. An investor can use these ‘business cycles’ to their advantage by identifying the phases in which the specific companies can benefit from. 

For example, when an economy expands some sectors such as consumer staples and pharmaceuticals might not post much incremental growth, however, companies related to the capital expenditure sector may post multi-fold profit growth.

Let us understand this with a practical example. A growth or expansionary phase of an economy is identified by the increased confidence of consumers, high-capacity utilisation of plants, increased demand for consumer discretionary products and sizable opportunities for jobs. In this phase, the companies belonging to sectors such as financials, real estate, metals and consumer discretionary tend to post superior revenue growth. Similarly, there are clear signs when a business cycle is said to be in slump. These are, layoffs, low sentiment of consumers, low-capacity utilisation of plants and spending cuts by corporations and households. In such a phase, stocks of companies from defensive sectors such as technology, consumer staples, and pharmaceuticals tend to do well. Looking at these dynamic macro-economic indicators, a savvy investor can figure out a current phase of a business cycle and invest accordingly. These indicators can help an investor select the right sectors and then focus on companies within those sectors. This top-down approach of identifying companies based on business cycle investing can reward an investor with handsome risk-adjusted returns.

Though these indicators are easy to understand and grasp, the trick lies in spotting them much before they become a new normal in the markets. Keeping an eye on global and domestic macro-economic indicators, sectoral undercurrents and then selecting right stocks can be a herculean task for an average investor. So, it makes sense to hand over your money to able and experienced hands in the markets. Investors can consider a mutual fund scheme specifically dedicated to the theme of business cycle.

A business cycle fund is an open-ended equity scheme which follows a top-down approach in identifying companies in its portfolio. These schemes are benchmarked against broad market indices. They follow a clear objective of investing in companies which are likely to benefit from a current trend in the business cycle of an economy. Since changes in the composition of these schemes are tightly-linked to changing phases of a business cycle in an economy, they suit investors who want to invest with a long-term time-frame in mind.

A sift through the portfolio composition of these schemes in the current market conditions show that their fund managers are bullish on sectors or themes closely-related to the domestic economy. Fund houses which offer such schemes based on the theme of business cycle have largely taken into account various market risks such as persistent geo-political uncertainties in various geographies, high inflation, slowdown in global growth and volatile crude prices.

As regards investments, investors heavily invested in mutual funds’ schemes which follow bottom-up investment strategy can consider investments in this scheme as a tool of diversification. Furthermore, one should have a long-term approach when investing in such type of scheme given that fund manager calls may take time to play out