Invest smarter: Leverage business cycles for better portfolio returns

In the dynamic world of finance, investors are constantly seeking avenues to maximise returns while mitigating risks. One critical yet often overlooked aspect is the understanding and capturing of business cycles. These cycles—characterised by periods of expansion, peak, contraction, and recovery—play a pivotal role in shaping the performance of various asset classes and investment strategies.

Understanding business cycle

Business cycle unfolds in four distinct phases:

1. Expansion: During this phase, interest rates are typically low, prompting increased borrowing for consumer spending and business expansion. This leads to rising production, corporate profits, and GDP growth.
   
2. Peak: The economy reaches its maximum growth rate. However, businesses may struggle to meet escalating demand, causing inflationary pressures and a subsequent rise in interest rates.
   
3. Contraction: This phase is marked by falling profits, consumer spending, and stock values, leading to a recession. Governments and central banks may intervene with interest rate cuts and fiscal stimulus to spur economic activity.
   
4. Recovery: The economy rebounds from its trough as the policies implemented during the contraction phase take effect, driving business expansion, rising stock values, and increased employment, income, and GDP.
   

Why Capturing Business Cycles Matters

• Insight into economic health
  

Business cycles offer invaluable insights into the overall health of the economy – by analysing indicators such as GDP growth, unemployment rates, consumer spending, and industrial production. These can help investors gauge the current stage of the business cycle. Understanding whether the economy is in a phase of growth or contraction enables investors to make informed decisions about asset allocation and portfolio positioning, making them better equipped to invest in the right set of sectors or asset classes.

• Asset allocation strategies
  

Different asset classes react differently to various phases of business cycles. For instance, equities tend to outperform during periods of economic expansion, while bonds and defensive sectors like utilities and consumer staples may fare better during economic downturns. By aligning asset allocation with the prevailing stage of the business cycle, investors can optimise returns and minimise portfolio volatility, making business cycles a powerful tool in the investing game.

• Risk management
  

Capturing business cycles is integral to effective risk management. Economic downturns and market corrections can erode portfolio values and expose investors to heightened risk. By diversifying across asset classes and sectors with varying sensitivities to business cycles, investors can mitigate the impact of adverse market conditions and safeguard their investment capital.

• Timing of investment decisions
  

Timing is critical in investing, and understanding business cycles can aid in making well-timed investment decisions. For instance, deploying capital into equities at the onset of an economic expansion or reallocating to defensive assets during the late stages of a bull market can enhance long-term returns and protect against downside risk.

Business Cycle Investing Based Mutual Funds

For many investors, understanding the present business cycle and forecasting future ones requires a deep understanding of intricate macroeconomic indicators and top-down analysis. This is where professionally managed mutual funds specialising in business cycle investing come into play.

Currently, there are nearly a dozen offerings based on the business cycle theme. Most of these funds offer flexibility to invest across market caps, themes, and sectors, without capping or minimum investment requirements, facilitating portfolio diversification.

By leveraging insights derived from business cycle analysis, investors can capitalise on favourable market conditions and avoid potential pitfalls, ultimately enhancing portfolio returns and achieving long-term financial objectives.

Disclaimer: The article is authored by Pavwan Chhabra, Partner at Kresko Wealth. The opinions expressed are those of the author and do not necessarily reflect the views of Business Insider India. Do your own research (DYOR) before deciding to invest in any financial asset class. This article is published by the Insider Studios team. You can get in touch with them on insiderstudios@businessinsider.in.