Policies, Codes & Other Documents
SEBI mandated that multi-cap funds have to invest 75% of total underlying funds in equities, within this multi-cap funds are required to invest at least 25% into large-cap, mid-cap, and small-cap stocks respectively. This was done with the intent to ensure that these funds have a well-diversified portfolio which is the basic premise or defining feature of multi-cap funds.
The fund managers were earlier allowed to allocate the funds of the scheme as per their preference, fund managers and investors preferred higher exposure in large-cap stocks. However, given the current mandate, there is a need for fund managers to invest in all types of market cap stocks. After this mandate, SEBI allowed funds to be introduced in a new category called the flexi cap funds. This category of funds is allowed to invest flexibly across a preferred segment of stocks. Following this announcement by SEBI, many of the mutual fund houses moved their existing multi-cap funds into the flexi cap category, especially the ones with large AUM.
There is no restriction imposed by SEBI on Flexi Cap funds, as long as they have a minimum of 65% investment in equity at all points of time!
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Following the SEBI mandate, there has been serious confusion between the two. Largely, the investment objective of multi-cap funds and flexi-cap funds have always been similar as both invest in stocks across various market capitalizations.
Although, Multi cap fund offers a great diversification with the equity asset class, stock picking could be a challenge especially in the small-cap category, the exposure could particularly cost the performance during a market downtrend.
However, Flexi-cap funds, on the other hand, are mandated to invest at least 65% of their assets in equities, there is no restriction in terms of market-cap exposure. This provides the fund managers complete freedom to align the portfolio with the preferred segment based on market trends. However, if the fund manager is unable to foresee the market trends appropriately, there could be a severe downside risk.
Each of these categories is designed to work differently across market phases. Let us try to understand how each of these funds would perform across bull and bear phases in the market –
The bull phase is when the markets are moving up and the macroeconomic scenario is positive. This is the phase when mid-cap stocks and small-cap stocks rise sharply and can provide extraordinary returns. There is high liquidity, these companies operate without many constraints.
In such a phase, since multi cap funds are mandated to invest 25% in mid-cap and 25% in small cap funds, multi- will perform well in rally. However, in the case of flexi-cap fund, the allocation depends on the fund manager’s discretion as there is no mandate of a minimum 50% exposure in mid and small cap funds. Thus, in a bull phase, multi-cap funds usually outperform flexi-cap funds.
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Bear phase is when the market is in a downward spiral, during this phase midcap and small cap stocks are likely to suffer the most. These stocks/companies could experience high volatility and liquidity crunch making it tough to exit positions during this phase.
In this phase, since flexi-cap funds have the flexibility to allocate across market capitalization, they can reduce their exposure in small and mid-cap funds. This could shield the fund from a massive fall. However, multi-cap funds would still have to mandatorily invest a minimum of 25% exposure in midcap and small cap stocks even during the bear phase, this could potentially hurt the returns of the fund. Thus, in a bear phase, flexi-cap funds usually tend to outperform multi-cap funds.
Flexi-cap funds have the advantage of reducing their midcap / small cap stocks exposure to zero during a bear phase. Multi-cap funds, on the other hand, maybe well-positioned during a bull phase given their minimum 25% exposure in midcap and small cap stocks. Thus, flexi cap funds could outpace multi cap funds during a bear phase and multi cap funds could gain better as compared to flexi cap funds during a bull phase.
Thus, multi-cap funds are more suitable to investors with high risk profile and longer investment horizon of more than 5 years to allow this strategy to bear fruit. Investors who wish to take flexible exposure across market capitalization can consider investing in Flexi-cap Fund. Investors need to evaluate their existing portfolio market cap allocation, risk profile, investment horizon, and investment objective before choosing between the two.
However, if you wish to get your portfolio revisited and need expert opinion, please contact the Tata Capital Wealth Desk and expert professionals will be able to guide you through the same.
Policies, Codes & Other Documents