Flexi-cap funds: Smart choice amid high valuations, potential volatility

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Flexi-cap funds are back on investors’ radars. In August 2024, they recorded net inflows of Rs 3,513 crore, the highest among diversified-equity schemes. With Indian stock markets at record highs and valuations at elevated levels, investors are turning to flexi-cap funds, as they wish to rely on fund managers to dynamically allocate between large, mid, and small-cap stocks.

“Flexi-cap funds, with their inherent flexibility, are being preferred as they can better handle risk-off sentiment or volatility by adjusting the mix of large, mid, and small caps,” says Meenakshi Dawar, fund manager-equity investments, Nippon India Mutual Fund.

Navigating across market cap spectrum

Flexi-cap funds invest across market caps without fixed allocation limits. Fund managers have complete freedom to select stocks they deem attractive. Data from the Association of Mutual Funds in India (Amfi) shows that 39 flexi-cap schemes collectively managed Rs 4.29 lakh crore as of August 31, 2024.

“The strong inflows during the current volatile market are because flexi-cap funds offer the advantage of not being tied to fixed allocations across large, mid, and small-cap stocks. This flexibility to adjust portfolios dynamically enhances potential returns,” says Deepak Ramaraju, senior fund manager, Shriram Asset Management Company (AMC).

Balancing risk and reward

Flexi-cap funds allow maximum flexibility to fund managers. “Higher diversification by spreading investments helps balance risk and reward for these funds. Historically, flexi-cap funds tend to perform better in volatile markets due to this ease of spreading investments across the board,” says Varun Goel, senior fund manager–equity, Mirae Asset Investment Managers (India). Currently, many flexi-cap funds have tilted their portfolios heavily towards large caps.

Ramaraju highlights that mid and small-cap investments present growth opportunities, whereas large-caps offer long-term stability.

Flexi-cap schemes are tax-efficient. Rebalancing between large, mid, and small-cap schemes on one’s own attracts tax liability.

Allocation can get skewed

Since allocation is guided by the fund manager’s market view, there is the risk of a mismatch between the investor’s desired allocation and the fund’s allocation to various market caps. If the fund manager takes high exposure to mid and small-cap stocks, it could result in higher risk than is desirable for the investor.

Who should invest?

Flexi-cap funds are ideal for investors who lack the time or expertise to manage allocations across market caps.

These funds have the potential to generate wealth over the long term. “Investors with a moderate risk profile and looking for long-term wealth creation should pick a flexi-cap fund. Due to the balanced risk and reward profile, they tend to give higher returns over a longer period,” says Goel.

Investors entering them should have a minimum five-year horizon. “Flexi-cap allocations can be considered for the core equity portfolio. Investments can be made across lump-sum and systematic (SIP/STP) modes,” says Dawar.

Before investing, review the fund’s historical allocation to market caps. “Investors must assess the fund manager’s ability to diversify and allocate effectively across large, mid, and small caps during different market phases,” says Ramaraju.

For those wanting to avoid fund manager risk, index funds that track the Nifty 500 or BSE 500, which invest around 70 per cent in large caps and the rest in mid and small caps, might be a better option.

“Depending on risk appetite, around 25 per cent of equity investments can be allocated to flexi-cap funds,” says Ramaraju.