Flexi- or multi-cap fund? Go by risk appetite, not by past returns

Multi-cap funds, with their higher exposure to mid- and small-caps, can outperform but with higher volatility

Both multi-cap funds and flexi-cap funds have given single-digit returns year-to-date (YTD) in 2022. The multi-cap category, which has asset under management (AUM) of Rs 66,569 crore, has given a return of 7.03 per cent. The older and much larger flexi-cap category, which has an AUM of Rs 2,52,855 crore, has given a return of 3.19 per cent YTD. Experts say investors should be guided by their risk appetite, and not go by past returns, when choosing between the two categories.

Investment mandate

Both categories are allowed to invest in large-, mid- and small-cap stocks. However, while flexi-cap fund managers enjoy complete freedom to decide their allocation to various market caps, managers of multi-cap funds must allocate a minimum 25 per cent each to large-, mid- and small-cap stocks.

Current portfolio composition

Currently flexi-cap schemes’ average allocation to large-, mid- and small-cap stocks is 82.9 per cent, 14.1 per cent and 3.1 per cent respectively. These schemes mostly benchmark themselves against the Nifty 500 index, which is heavily tilted towards large-cap stocks.

Multi-cap schemes’ average allocation is 60.1 per cent, 31.7 per cent and 8.2 per cent respectively. These schemes mostly use the Nifty 500 Multicap 50:25:25 TRI as their benchmark.

Why did multi-cap funds outperform?

Multi-cap funds, in their current avatar, don’t have a long track record as they got their mandate in January 2021. Over the past two years, mid- and small-cap stocks have outperformed large-caps. Multi-cap funds’ higher allocation to these stocks has enabled them to outperform flexi-cap funds.  

The market fall between October 2021 and June 2022 and the subsequent revival has also helped. “Most asset management companies (AMCs) launched this category in the past one year. Since they deployed their funds when the market was down, that has helped the category fare better than flexi-cap funds,” says S Sridharan, founder & principal officer, Wealth Ladder Direct.

Which is a better bet now?

If the markets witness a broad-based rally, multi-cap funds are likely to outperform. But if there is a narrow rally in large-cap stocks, as happened in CY2019, then flexi-cap funds may do better, provided their fund managers get their calls right.

As for their long-term prospects, Ravi Kumar TV, founder, Gaining Ground Investment Services says: “While both categories are well diversified, multi-cap funds may outperform flexi-cap funds marginally over the long term. However, if a flexi-cap fund has a 60-70 per cent allocation to mid- and small-cap stocks, it could also give good returns over the long term,” says.

Factor in your risk tolerance

Investors are likely to witness different levels of volatility in these two categories. “There is a likelihood that multi-cap funds, with their mandatory allocation to mid- and small-cap stocks, may in general be more volatile than flexi-cap funds, which have historically maintained a higher allocation to large caps most of the time,” says G Pradeepkumar, chief executive officer (CEO), Union AMC.

Investors must take into account their existing and targeted asset allocation (chiefly, their allocation to mid- and small-cap stocks) before selecting one of these two categories. They should also factor in their risk appetite.

“Those with high risk-taking ability may invest in multi-cap funds while moderate risk takers may opt for flexi-cap funds,” says Sridharan.

Risk-averse investors may avoid multi-cap funds as they may not want a 50 per cent allocation to mid- and small-cap stocks.

Flexi-cap funds are a good choice for novice investors starting their investment journey. “A flexi-cap fund offers a good initial experience of a diversified equity fund with much lower volatility than a multi-cap fund,” says Ravi Kumar.

Irrespective of the category you choose, invest with a minimum five-year time-frame and take the systematic investment plan route. With the markets touching new highs, a correction can’t be ruled out.

Investors can alternatively choose a prudent mix of separate large-, mid- and small-cap funds (say, in 70:20:10 ratio) to build a portfolio, provided they have the ability to choose the right schemes and rebalance periodically.