Analysing business cycle funds

We understand their investment strategy before examining their portfolios and performance

Business cycle funds: Should you invest in them?

Markets regulator SEBI restricts mutual fund houses to having one fund in each category. This has been done to ease the discovery journey of potential mutual fund investors.

Before this rule was enacted in 2017, investors were often bamboozled and eventually spooked by the sheer number of funds available.

So, to make investors' lives easy, the mutual fund landscape was carved into 40 categories, with a fund house allowed to have only one fund in each category.

However, fund houses found a way to bypass the regulation. Since there are several sectors (IT, financials, auto) and themes (consumption, infrastructure) in the market, fund houses recognised that they could launch as many funds in the sectoral/thematic category So, along came business cycle funds.

While the L&T Business Cycle Fund (now HSBC Business Cycles Fund) is a veteran, having launched a decade back, the nine other business cycle funds were rolled out in just the last four years. These 10 funds have also cobbled some popularity, managing assets worth Rs 21,500 crore as of December 2023.

Meaning of business cycles

As per one of the business cycle fund brochures, 'a business cycle is basically defined in terms of periods of expansion and contraction. During expansions, the economy is growing in real terms (i.e. excluding inflation), as evidenced by increases in indicators like employment, industrial production, sales and personal incomes. During contractions, the economy is contracting, as measured by decreases in the above indicators'.

In layperson's terms, if a fund expects the economy to expand, it may look at sectors that have historically boomed during such phases. On the contrary, if the fund expects the economy to fall, it may shift its money to relatively more resilient sectors.

Inter-fund comparison

But do these funds have a concrete strategy for choosing sectors?

To find the answer to this question, we compared their portfolio with flexi-cap funds and value funds belonging to the same fund house. (We compared business cycle funds with them because they can also invest across all companies. Therefore, it felt right to know whether they, in reality, have a distinct investment strategy over them.)

Here's what we found.

Sector-level differentiation
Of the ten business cycle funds, only five - HDFC , HSBC , Kotak , Mahindra Manulife and Quant - took independent sector calls to a reasonable extent (more than five per cent) and were not merely mimicking their in-house flexi-cap counterparts.

The rest - Aditya Birla Sun Life , Axis , Baroda BNP , ICICI and Tata - were near-identical.

Stock-level differentiation
At an individual stock level though, only one business cycle fund had more than a 50 per cent overlap with its in-house flexi-cap fund, which suggests that they have a mind of their own when it comes to picking stocks.

Business cycle funds vs flexi-cap funds

We look at the stock overlap and if business cycle funds have outperformed their flexi-cap rivals

Fund house Launch Date Overlap with flexi-cap fund (%) Beaten in-house flexi-cap fund
Aditya Birla SL 03/12/2021 59 Yes
Axis 22/02/2023 28 Yes
Baroda BNP Paribas   15/09/2021 33 No
HDFC   30/11/2022 38 No
HSBC 20/08/2014 26 Yes
ICICI Prudential   18/01/2021 44 No
Kotak   28/09/2022 42 No
Mahindra Manulife   11/09/2023 31 Yes
Quant   30/05/2023 47 Yes
Tata   04/08/2021 31 Yes
Portfolio disclosure for December 31, 2023

Only HSBC's business cycle fund has a long-term track record of 10 years. But the numbers aren't too pretty. It has managed to outperform its flexi-cap variant just 12 per cent of the time over a five-year daily rolling basis since inception.

That said, judging business cycle funds' potential based on a single fund would be unwise.

As for the rest of the nine funds, they are relative newbies that are yet to experience a complete market cycle of five to seven years. Furnishing their report card at this moment would be akin to jumping the gun on our part.

The last word

Since these funds are fairly untested and have a limited performance history, we suggest you go for a diversified equity fund. (A flexi-cap fund is one such example of a diversified equity fund). They have proven their mettle and are more cost-effective.

Also read: What are smart-beta funds?

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