On the face of it; multi cap and flexi cap funds; a part of the Indian mutual fund spectrum, would appear to be siamese twins. Both allot a similar (65-75 per cent) of their invested funds into equities and the rest into other asset classes.
But dig a little deeper into aspects like investment strategies and priorities and you find that these are in almost separate worlds.
“While both multi-cap and flexi-cap funds invest in stocks across market-caps i.e. large, mid and small sized companies, there are some important differences that investors should be aware of while selecting these funds,” says Virendra Somwanshi, Head - Wealth Management, Capital Markets and NRI Business, Bank of Baroda.
The story starts with SEBI’s product categorization circular issued in October 2017 that came into effect in June 2018. That circular allowed multi cap funds to invest 65% of their assets in equity and equity related instruments across large cap, mid cap and small cap stocks.
Later, in September 2020, SEBI mandated multi cap funds to maintain an exposure of at least 25% each in large cap, mid cap and small cap stocks in order to provide greater diversification to multi cap fund investors.
On the flip side however, this mandate limits the fund manager’s ability to leverage opportunities based on their outlook because at times it may be necessary to underweight (lessen) exposure to a particular segment that is expected to do poorly which would mean contravening the minimum 25% allocation mandate.
Thus, in November 2020, SEBI introduced flexi cap funds which are similar to multi cap funds but follow a flexible investment mandate.
The key difference between multi cap and flexi cap funds is the flexibility the latter has in changing allocation between large caps, mid caps and small caps while ensuring 65% of its assets are allocated to equity and equity related instruments.
To illustrate, if the fund manager feels a need to reduce exposure to small caps during economic uncertainty, they may reduce the allocation to zero and increase the allocation to large caps/mid caps.But a multi cap fund can’t manage its portfolio in such a dynamic manner.
“This means that flexi cap funds can allocate their capital considerably more freely among various stocks. The category's fund manager has the flexibility to rebalance the portfolio between big, mid, and small capitals as market conditions warrant. Since multi-cap funds must allocate at least 25% of their assets across each of the market cap categories, they lack this flexibility,” points out Abhinav Angirish, Founder of Investonline.in.
So strategy is the key differential between these types of funds.
“A multi-cap fund invests in different market cap companies that include large-cap, mid-cap, and small-cap stocks but they mainly invest in large-cap stocks which makes it less risky whereas flexi cap funds are a type of equity funds that covers stocks from various sectors and market capitalization. Hence, the fund is strongly diversified which helps in managing risk during market volatility,” notes Neeru Seal, Senior Consultant, Alpha Capital.
“The definition (mandate) of multi cap funds, requires that they have a minimum of 25% invested in each of large caps, midcaps, and small caps. Hence, regardless of how the fund managers feel about the markets, multi cap funds can't have less than a 25% allocation to equities in any one market cap category,” says Angirish.
It may be further explained that flexi cap funds can allocate their capital considerably more freely among various stocks. The category's fund manager has the flexibility to rebalance the portfolio between big, mid, and small capitals as market conditions warrant. Since multi cap funds must allocate at least 25% of their assets across all market cap categories, they lack this flexibility, according to experts.
So now that the strategy is understood, the key differential from here on is the investor’s priorities and risk taking appetite.
“As Multi-cap funds must mandatorily allocate minimum 50% to mid and small-caps, they are usually more volatile and can potentially deliver alpha (returns) as compared to a flexicap fund over a long duration,” says Somwanshi.
If an investor has a higher investment horizon (greater than 5 years) and a higher risk appetite, they may consider multi-cap funds.
On the other hand, if the investment horizon is shorter or the risk profile of the investor is relatively lower, they may consider parking their equity investments in flexi cap funds where the fund manager has the flexibility to invest across large, mid and small cap companies without restrictions.
There is even another perspective to consider.
“When a fund gets huge, the management has less room to cut losses in a market cap section that is expected to perform poorly in the near future. Thus, multi cap funds are a good option for individuals that have a longer investment horizon and a relatively larger risk tolerance,” explains Angirish about the dynamics from the fund manager’s perspective.
“As an advisor we would suggest go with a multi-cap fund if you can handle the volatility that comes with 50 per cent allocation to mid- and small-cap stocks,” Seal. Otherwise, you can opt for a flexi cap fund which, on an average, has only 25-30 per cent allocation to mid- and small-cap stocks.
At the end of the day the investor needs to make his/her Investment decisions after doing thorough research about the financial instrument into which they are planning to invest, investment objective, risk tolerance, and time horizon.
The other AUM
So if 65 to 75 per cent of the AUM (Assets under management) go into the equity segment, what about the remaining 25 to 35 per cent that the fund manager has the option of investing into other asset classes.
From the regulatory standpoint, both types of funds have the flexibility to invest 25 to 30% in debt or cash.
Historically the allocation to non-equity components has not been very high as these funds are positioned as pure play equity mutual funds and rarely take an active cash call.
“The non-equity component, if any, may be tactically utilised for market opportunity purposes and thus investors in this category of funds should essentially focus on the equity component of these fund categories and have commensurate risk appetite as well as a long-term investment horizon,” advices Somwanshi.
Flexi-Cap funds and multi cap funds have some portion allotted to non equity investments like bonds etc. Therefore, sometimes confusion arises about tax treatment of gain on selling these funds.
“Even if flexi cap funds and multi cap funds have non equity portions, flexi cap & multi cap funds are considered as equity oriented funds for taxation purpose,” says Sujit Banger, Founder of Taxbuddy.com.
Thus, gains made within less than 12 months from a flexi-cap or multi cap scheme are taxed at 15% flat, irrespective of the slab rate. If it is more than a year, profits will be taxed flat at 10% after the initial exemption of Rs. 1 lakh.
Manik Kumar Malakar is a personal finance writer.