Multi-cap fund is the category of equity-oriented schemes which invest a minimum of 25% each in three market capitalisations i.e., large-cap, mid-cap and small-cap. A multi-cap fund aims to offer the best of all three market caps in one scheme as largecaps can provide stability and liquidity and mid & smallcaps may provide potential higher returns, albeit with high volatility.
In my view a good actively managed multi-cap category scheme should have following 3 important prerequisites:
“High active share” - one of the necessary ingredients for potential Alpha generation
• Active share is a measure of the percentage of security holdings in a manager's portfolio that differs from the benchmark index. It tracks the disparity between a portfolio manager's holdings and that of its benchmark index.
• A low active share score is said to indicate that a portfolio manager is closely replicating the target index (benchmark) and engaging in a passive investment strategy.
• A high active share score is said to indicate that a portfolio's holdings diverge from the target index (benchmark), and the portfolio manager is actively managing the portfolio.
• Managers with high active share have potential to outperform their benchmark indices.
Portfolio manager can add active share by:
-Being underweight or avoiding securities present in the benchmark
-Being overweight on securities present in the benchmark
-Adding securities that are not part of the benchmark
Categories of portfolio based on active share:
• Active share of ~50% or higher is generally considered active management
• An active share of ~20% to 50% is considered closet indexing
• And an active share of less than 20% is considered passive
“Reasonable allocation to small and mid-cap segment”- higher Alpha generation opportunities in the segment
Small and mid-cap segment provides higher Alpha generation opportunities since it has availability of broad spectrum of diversified and niche businesses and also is relatively less researched. Avoiding corporate governance issues is equally important in this segment. Hence, large in-house research capabilities matter a lot for identifying winners in this segment and an internal forensic team to create negative list of stocks to help in avoiding large corporate governance issues.
“Factor diversified balanced portfolio” - for better investing experience with low Alpha volatility.
Broader market index (such as BSE 500) is a amalgamation of various factors like value and growth stocks, cyclical and defensive sectors, domestic and export oriented businesses, large, mid and small-cap stocks.
Following a narrow style or theme bias approach for portfolio construction has its on challenges:
· Value style under-performed for 3 years: Before the come back in CY 2021, for three consecutive calendar years (2018, 2019, 2020), value style underperformed most of the other styles of fund management.
· Roller-coaster ride with quality style: Quality style worked well in CY 2018 and CY 2020 but did poorly in CY 2017 and CY 2019.
· Domestic v/s export oriented theme: Sectors like IT services and pharma were among the worst performing sectors in CY 2016 and 2017 compared to broader market. Subsequently, IT services outperformed most of the other sectors in CY 2018, 2020 and 2021, and pharma outperformed in 2020.
· Defensives v/s cyclicals: Some of the defensive sectors did well in CY 2020 but in CY 2021 many of the cyclical sectors performed relatively better than broader market and defensive sectors were among the laggards.
No particular style performs consistently every year. Likewise, sector and market cap performance keeps rotating year on year. Furthermore, there may be prolonged cycle of outperformance and underperformance. Hence, a factor diversified balanced portfolio with blend of these factors can help improving consistency of the performance.
To conclude: “By embracing a high active share strategy, focusing on stock selection, with an aim to unlock the full potential of the market capitalisation spectrum, a factor diversified balanced Multi Cap portfolio may achieve not only high potential alpha for its investors but better investing experience as well with low alpha volatility”.
Data Source: MFIE and Internal Research. Value = Nifty 500 Value 50 TRI, Quality = Nifty 200 Quality 30 Index. For illustration purpose only. Past performance may or may not sustain in future.
Views are personal.
Manuj Jain is Associate Director, Co-Head Product Strategy, WhiteOak Capital AMC.
