Amidst booming markets, there are times when we forget that every segment goes through cycles of contraction and expansion.

Both the macroeconomy of a country as well as businesses have their own phases of boom and bust. Some segments are in sync with the events in the economy, while others have an independent trajectory.

Generally, the economic cycles come as full recession, early recovery, full recovery, and early recession. Individual businesses may fare differently with their own cycles and so defensives, cyclicals and growth stocks or sectors may be favoured at various points in time.

The whole point of business cycle investing is to ensure appropriate sector rotation to ensure the upside of a cycle is well-captured, while minimising the effects of the downward phase.

As an innovation on top of these aspects, Edelweiss Business Cycle – a new fund offering – is  seeking to add factor-based investing to identify the ebb and flow of different sectors and juggle the portfolio accordingly. And the scheme is looking to employ multiple factors towards this investment style.

The NFO closes on July 23.

Read on take an informed call on whether you must invest in this business cycle fund.

Adding factors to identify cycles

Moving away from identifying business cycles in the traditional way, the fund believes such a method does not result in adequate sector rotation and thus may not be rewarding enough. And so, it has taken to application of factors. Normally, quality, momentum, value, and growth styles operate in isolation.

Edelweiss Business Cycle fund seeks to use a combination of factors. It will first apply each of the above factors to a universe of 300 stocks. Each stock will be scored on quality, momentum, growth, and value.

This is where it gets interesting. Now, in the resultant set of stocks after the above process, the best momentum picks from the value, growth and quality top-rankers are taken based on combination scores. So, the top-ranked stocks from the scores of value + momentum, quality + momentum and growth + momentum combinations are selected.

Edelweiss Business Cycle fund will thus arrive at a portfolio of around 60 stocks. Data from the fund’s back-tested data (as if May 2024) indicates that the portfolio will have large caps to the tune of 40 per cent, midcaps to the extent of 51 per cent and around 9 per cent in small caps.

The fund may thus largely resemble a large & midcap scheme in terms of market capitalization.

Edeweiss Business Cycle fund has fairly impressive back-tested returns data. Across timeframes – short, medium and long terms – the fund has beaten the Nifty 500 TRI comprehensively. On a 5-year rolling returns basis from November 2016 to May 2024, the fund has beaten the Nifty 500 TRI all the time.

What should investors do?

Despite trying to rotate sectors and benefit from all fluctuations, business cycle funds can be volatile, and returns can be lumpy.

Edelweiss Business Cycle fund’s back-tested data is quite healthy. But the replicability of this performance in the future may be challenging. The success of the strategy of using multiple factors remains to be seen over the long term.

Given the Indian economy’s steady growth prospects over the next few years, business cycle funds can gain by riding on sectors benefitting from the uptrend.

Currently, only two business cycle funds – from HSBC and ICICI Prudential – have a track record of more than three years. Both funds have delivered well and outperformed the Nifty 500 TRI and BSE 500 TRI over the past few years and must be the first choices for investors looking to take exposure to business cycle funds.

However, given the innovation in the style adopted by Edelweiss Business Cycle fund, investors with a reasonably robust risk appetite can consider small SIPs in the scheme for the long term.

Exposure must be limited to a tiny portion of the satellite portion of an investor’s portfolio.