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Why Multi-Cap Funds Are Best Bet

Enter multi-cap funds only if you can stay invested for the long term.

Multi-cap funds have outpaced flexi-cap funds over the past year.

While the former have given a category average return of 7.59 per cent, the latter have fetched 3.18 per cent.

One key reason for this is that mid and small-cap stocks have outperformed large caps over this period (please see chart).

While diversification across asset classes is important, it is equally important for investors to stay invested across sub-asset classes, like large, mid and small-cap stocks.

Investors can take exposure to them through separate funds, or via multi-cap funds.

Sebi’s mandate

In the October 2017 Securities and Exchange Board of India guidelines on rationalisation and categorisation of mutual fund schemes, the regulator had stated that multi-cap funds should have at least 65 per cent exposure to equities, with allocation across market caps.

In October 2020, Sebi made it mandatory for multi-cap funds to invest at least 25 per cent each in large, mid and small-cap stocks.

Fund houses were asked to comply with this rule by January 2021.

In these funds, the fund manager rebalances the portfolio periodically to ensure the minimum 25 per cent exposure mandate is maintained.

Flexi-cap funds is a category where the fund manager has the freedom to invest across market caps without any restriction.

Diversification benefit

Investing in multi-cap funds allows the investor to build a diversified portfolio.

“Multi-cap funds can be all-weather funds as the diversity of market cap allocations helps the fund throughout various market cap cycles,” says Daylynn Pinto, senior fund manager, equity, IDFC Asset Management Company.

While large caps can provide higher stability to the portfolio, mid and small-caps tend to outperform during secular market rallies.

However, all categories have the potential to provide alpha.

Taking disciplined exposure across market caps allows investors to benefit, irrespective of which market cap performs.

“Multi-cap funds, with investments across the market spectrum, seek to provide a solution by reducing the need to time or make frequent changes to the portfolio, which can potentially reduce returns due to higher costs and timing mistakes,” says Sailesh Raj Bhan, deputy chief investment officer-equity investments, Nippon India Mutual Fund.

According to Tarun Birani, founder and CEO, TBNG Capital Advisors, “These funds can take exposure to sectors and stocks across market caps. This reduces the chance of missing out on opportunities across the market cap spectrum.”

In flexi-cap funds, where the fund manager takes the call on which market cap to have higher exposure to, there is the risk of underperformance if his call goes wrong.

Outperform during broadmarket rallies

Multi-cap funds perform better when mid and small-cap stocks are doing well.

These two segments are better represented within multi-cap funds with a minimum 25 per cent allocated to each.

Flexi-cap funds can miss out on a rally in mid and small-cap stocks if the fund manager has higher exposure to large caps (as is currently the case).

Who should go for them?

Investors may want to allocate money across market caps through separate funds.

But they must have the discipline to rebalance across sub-asset classes regularly.

Moreover, when investors sell one category of funds and re-allocate to another, there is a tax incidence.

“Many investors may not be able to decide on the appropriate mix of market caps. Multi-cap funds provide an automated solution and help investors participate across the market cap range,” says Bhan.

Exposure to mid and small caps stocks can make these funds volatile.

“Multi-cap funds are a double-edged sword. When the markets tank, multi-cap funds can also underperform as higher exposure to mid and small caps,” says Birani.

Investors who are not comfortable with a fund that has at least 50 per cent exposure to mid and small-cap stocks should avoid multi-cap schemes “as mid and small caps tend to be more volatile, especially in the short term,” says Pinto.

Invest systematically

Enter multi-cap funds only if you can stay invested for the long term.

“The time horizon should be more than five years,” says Birani.

Pinto advises conservative investors to take exposure to these funds via the SIP (systematic investment plan) route.

Investors may allocate up to 15-20 per cent of their equity portfolio to them.

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Feature Presentation: Aslam Hunani/Rediff.com

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