If you are among those who want to benefit from a stock basket that is designed to gain from various stages of business cycles, here is a new offering that may be of interest to you. A new Kotak Business Cycle Fund, an open-ended scheme, would invest in stocks and sectors of the companies that can navigate through economic cycles. This will be the sixth such fund in this thematic sub-category. ABSL, Baroda BNP Paribas, ICICI Prudential, L&T and Tata mutual funds have similar offerings. Let us take a close look at this new fund offer, which closes September 21, 2022.

Understanding cycles

The classical business cycles are identified as recurrent, alternating phases of expansion and contraction in a large number of economic activities. By navigating business cycles accurately, an equity fund can become an all-weather investment vehicle.

Do note companies have their own cycles -- startup, growth, mature and decline. Similarly, each business has a life cycle that starts with demand going up, price rising, higher capacity utilisation, higher supply, then fall in prices and it goes on. Each corporate sector has its own cycle too.

Identifying the business cycle requires a nuanced understanding. This can be done with the help of indicators related to global macro, domestic macro, investment and business & consumer confidence. Take a look below at various sentiments across business, consumer and investor in different stages of cycle.

There is a lot of theory about which stocks/sectors should perform across early cycle, mid cycle, late cycle and downturn. For instance, conventional wisdom says when interest rates are low, banking, capital goods, consumer discretionary etc. will do well. When interest rates are high, tech, pharma, power and telecom will perform better. Unfortunately, individual sectors do not fall in the same pattern each time. This means active fund management is a must-have to navigate and profit from business cycle dynamics.

While the Indian economy is slated for growth in the long-term, it will experience various business cycles and it is important as an investor to move across sectors to benefit from the growth potential.

Kotak Business Cycle Fund approach

The new offering aims to adopt a four-pronged approach to play business cycles optimally. One, it will have a top-down and bottom-up approach so as to identify sectors and good companies within them. Two, the fund doesn't want any cap on market cap and thus wants to leverage the flexibility to buy into all market cap segments. Three, it will aim for diversification across sectors. Four, the AMC's investment committee will act as a sounding board for stock ideas.

As we understand, the business cycle theme investing allows a fund to consider aggressive sector over/under weight calls as compared to other diversified funds across different economic phases. Take a look at the table below on how peer business cycle funds have performed. Note that most of them do not have a long-term track record.

The Kotak Business Cycle Fund will invest at least 80 per cent of the portfolio as per business cycles theme. The fund has the flexibility to go overseas for investments and this can be handy in a period of domestic recession. As per its scheme information document, the fund may invest up to maximum of 30 per cent in units of overseas mutual funds schemes/ETFs with similar investment objective or strategy / foreign securities having business cycle theme.

Kotak Business Cycle Fund will take into account various economic parameters (GDP growth, current account deficit, corporate profit growth trend, inflation etc.), investment indicators (investment in capex, capacity utilisation, credit growth, etc.), business and leading economic indicators (business confidence index, purchasing manager index, etc.) before committing any investment.

Not just the upturn, a well-managed business cycles fund even during challenging times of economic slowdown should be able to select companies that can manage challenges and perform well across various economic parameters.

The fund will be benchmarked against the Nifty 500 Total Return Index (TRI). Fund manager for equity will be Pankaj Tibrewal and Abhishek Bisen for debt.

Final words

Investors should note a few things before investing in thematic funds.

First, any thematic fund should be part of your satellite portfolio, and not core portfolio.

Second, timing of entry and exit is important when it comes to sectoral calls. Though business cycle investing is an appealing theme, the actual portfolio performance will only be good when there is accurate identification of business cycles and relevant portfolio allocation. This remains a tough task and repeating the same, over many cycles, is even tougher. This is where the fund management team will be tested.

Three, business cycle investing, like any form of investing, requires good fund management skills. Kotak AMC’s small cap, mid cap, infra, tax saver and equity opportunities schemes rank among the top-10 in the respective categories on a three and five-year basis. Since this is a new theme, it is best to wait for the fund to build a track record before you commit serious money.