Biz cycle funds can generate alpha but carry risks: What should you do?

Higher concentration and fund manager risk make these funds apt only for seasoned investors

Mahindra Manulife Asset Management Company’s (AMC) new fund offer (NFO) of its business cycle fund began on August 21 and will close on September 4, 2023. Nine such funds manage assets worth Rs 18,358 crore (data as on July 31, 2023). While fund houses present business cycle funds as an avenue to invest in promising businesses with the potential to fetch high returns, investors need to evaluate these funds thoroughly before betting on them.

Nature of a business cycle fund 

Economies and financial markets witness cycles. Capturing the growth phase of these cycles can lead to substantial wealth creation. Fund managers of these funds aim to invest in stocks that are expected to experience a marked improvement in cash flows. “Business cycle funds aim to capture the phase of economic expansion. They invest in businesses with high earnings growth visibility and in whose earnings forecast there is a high degree of confidence,” says Ravi Kumar TV, founder, Gaining Ground Investment Services.

Fund manager risk 

The fund manager’s role is pivotal to the success of these schemes. “If the fund manager identifies the cycle correctly, the scheme will outperform diversified-equity funds. Conversely, if calls go wrong, the scheme could lag behind the broader markets,” says Parul Maheshwari, a certified financial planner.

Concentration risk 

The fund manager of a business cycle fund often focuses on three or four key sectors or themes that are likely to do well in the future. These funds also tend to run concentrated portfolios of stocks belonging to all market caps. “Business cycle investing involves an element of market timing, which can be challenging even for seasoned professionals. Additionally, concentration in specific sectors can lead to higher risk. Investors need to evaluate the fund’s adaptability to shifting economic conditions,” says Ravi Kumar.

Overlap with other funds 

While constructing the portfolios of these schemes, a fund manager could end up duplicating the portfolios of other diversified-equity schemes. “Executing the strategy of identifying business cycles and moving in and out of sectors at the right time consistently is difficult. Furthermore, established diversified-equity funds can also employ this strategy. Most active fund managers do try to invest, or maintain overweight positions, in promising companies or sectors that are expected to do well over the next few years. Hence, the business cycle strategy does not appear to provide any significant differentiation,” says Shrinath ML, senior research analyst, FundsIndia.

What should you do? 

While a business cycle fund appears appealing, it carries higher risk and offers no clear promise of greater rewards. Investors willing to put in their money for five years may be better off investing in a multi-cap fund that requires fund managers to invest at least 25 per cent in all three market caps (large, mid and small).

“We don’t recommend this category as timing business cycles consistently across sectors is a very difficult task. Moreover, most funds in this category lack a long-standing track record of executing this strategy consistently,” says Shrinath ML.

If you are still keen to invest in a business cycle fund, make a limited allocation. “One can invest up to 10 per cent of that entire equity portfolio in these funds. As in any other equity fund, one should remain invested across a business cycle, that is, for at least five years, to realise the potential gains from these funds,” says Maheshwari.

According to her, since these funds take concentrated exposure to a few sectors, they can be risky for first-time or conservative investors. “However, investors who have already built a core mutual fund portfolio using diversified-equity funds, and now wish to generate higher returns through their satellite portfolios, may consider allocating to these funds,” she says.