Q. I am a 32-year-old business owner, running my small business in Ghaziabad. I have been investing in equity mutual funds. I now intend to diversify my portfolio and invest in hybrid funds too. I intend to invest in either flexi-cap funds or multi-cap funds, I have undertaken some initial research, however, both categories seem similar to me. Can you please elaborate on the differences between flexi-cap funds and multi-cap funds and what are the pros and cons of investing in flexi-cap and multi-cap funds.
If you are looking for long-term wealth creation through equity mutual funds, you will definitely come across two categories of funds: multi-cap funds and flexi-cap funds. Both these funds invest in stocks of companies across different market capitalizations, such as large-cap, mid-cap and small-cap.
However, there are some key differences between them that you should know before investing. In this article, we will explain the difference between multi-cap and flexi-cap funds, including their investment mandate, functioning, pros and cons, and suitability for different investors.
What are multi-cap funds?
Multi-cap funds are types of equity funds that diversify their investment in different market capitalizations which are large-cap, mid-cap, and small-cap companies. As per the SEBI circular issued on 11 September 2020, multi-cap funds are required to have a minimum 25% allocation of their portfolio in each of these segments. This means that at least 75% of the total assets of a multi-cap fund must be invested in equity and equity-related instruments, and the remaining 25% can be invested in debt, cash or other securities.
What are flexi-cap funds?
Flexi-cap funds are types of mutual funds that diversify their investment in companies belonging to different market capitalizations and sectors. A flexi-cap fund is an open-ended, dynamic equity scheme that can invest in any proportion of large-cap, mid-cap and small-cap stocks as per the fund manager's discretion. A minimum of 65% of the total assets of a flexi-cap fund must be invested in equity and equity-related instruments, and the remaining 35% can be invested in debt, cash or other securities.
How do multi-cap and flexi-cap funds function?
Multi-cap and flexi-cap funds function by investing in a portfolio of stocks that represent different segments of the market. The fund manager selects the stocks based on various factors such as growth potential, valuation, earnings quality, competitive advantage, etc. The fund manager also adjusts the portfolio allocation according to the changing market conditions and opportunities.
The main difference between multi-cap and flexi-cap funds is the degree of flexibility that the fund manager has in choosing the stocks. While a multi-cap fund has to follow a fixed allocation of 25% each in large-cap, mid-cap and small-cap stocks, a flexi-cap fund can vary the allocation as per the fund manager's view.
For example, a flexi-cap fund can increase its exposure to large-cap stocks if the fund manager expects them to perform better than mid-cap or small-cap stocks, or vice versa.
What are the pros and cons of investing in multi-cap and flexi-cap funds?
The pros and cons of investing in multi-cap and flexi-cap funds depend on your risk appetite, return expectations and investment horizon. Here are some general points to consider:
- Multi-cap funds offer a balanced exposure to different segments of the market, which can reduce the overall volatility and risk of the portfolio. Multi-cap funds can also benefit from the growth potential of mid-cap and small-cap stocks, which may outperform large-cap stocks in certain phases of the market cycle.
- Flexi-cap funds offer more flexibility to the fund manager to capitalise on the opportunities in different segments of the market. Flexi-cap funds can also adjust their portfolio according to the changing market conditions and sentiments, which can enhance the returns and reduce the downside risk.
- However, both multi-cap and flexi-cap funds carry higher risk than pure large-cap funds, as they invest in mid-cap and small-cap stocks that are more volatile and prone to market fluctuations. Both multi-cap and flexi-cap funds also have higher expense ratios than index funds or exchange-traded funds (ETFs) that track a specific market segment.
- Moreover, both multi-cap and flexi-cap funds depend on the fund manager's skill and judgement to select the right stocks and allocate them optimally. Therefore, it is important to check the fund manager's track record, experience and investment philosophy before investing in these funds.
Why many multi-cap funds have converted into flexi-cap funds?
Many multi-cap funds have converted into flexi-cap funds after SEBI introduced a new category called flexi-cap fund on 6 November 2020. The reason for this conversion is that many fund managers felt that the new mandate of multi-cap funds to have a minimum 25% allocation in each of the large-cap, mid-cap and small-cap segments was too restrictive and took away their flexibility to allocate to their preferred segments. By converting into flexi-cap funds, the fund managers can retain their existing portfolio composition and strategy without having to comply with the new norms.
Whether these funds are active or passive?
Both multi-cap and flexi-cap funds are active funds, as they do not follow a predefined index or benchmark. The fund manager actively selects the stocks and allocates them according to their own research and analysis. The fund manager also reviews and rebalances the portfolio periodically to align it with the changing market conditions and opportunities. Therefore, both multi-cap and flexi-cap funds charge higher fees than passive funds such as index funds or ETFs that simply replicate an index or benchmark.
Multi-cap and flexi-cap funds are suitable for investors who have a high risk appetite, long-term investment horizon (at least 5 years) and diversified investment goals. These funds can help investors capture the growth potential of different segments of the market while maintaining a balanced exposure. However, investors should also be prepared for higher volatility and uncertainty in these funds compared to pure large-cap or index funds.
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Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.