Seek mid, smallcap exposure but fear volatility? Try multicap funds

Diversified equity portfolios tend to reward investors in the long term. Indian mutual fund investors appear to have embraced this approach. According to the latest data from the Association of Mutual Funds in India (Amfi), multi-cap funds received net inflows of Rs 4,708 crore in June 2024, the highest among diversified equity schemes. Meanwhile, Franklin Templeton Asset Management Company (AMC) has launched the new fund offer (NFO) of Franklin India Multicap Fund. 

“Multicap funds are a good choice for investors since they provide a fair distribution of exposure to large, mid, and small companies. Value and growth are well-balanced in multi-cap fund portfolios,” says Manish Lodha, equity fund manager, Mahindra Manulife Mutual Fund.

A diversified offering

Multicap funds invest 25 per cent of their portfolio each in large, mid, and smallcap stocks. The remainder is invested at the fund manager’s discretion. “Multicap funds offer dedicated exposure, and hence participation, to all market cap segments. Diversification across market cap segments mitigates market cap-specific risk during periods of volatility,” says Ajay Khandelwal, fund manager, Motilal Oswal AMC.

Growth with stability

The largecap stocks in their portfolios provide stability while the mid- and small-cap stocks provide growth.

“Decent exposure to large caps provides overall portfolio stability while midcap and smallcap allocation provides adequate earnings delta to the portfolio. Hence, it is a good category over the medium term from a risk-adjusted returns standpoint,” says Ankit Jain, senior fund manager, Mirae Asset Investment Managers (India).

Volatility exists

Substantial exposure to mid- and smallcap stocks brings inherent volatility. “The level of risk goes up in a multicap fund if the smallcap exposure is relatively high. In the past, there have been several instances of small caps underperforming the broader market,” says Lodha. He adds that the capacity to invest nearly 50 per cent of these funds’ corpus in large companies can, however, serve as a mitigating factor.

Distinct from flexicap

In flexicap schemes, the fund manager has the discretion to allocate as much of his fund’s corpus as she likes to stocks of different market caps.

Despite this flexibility, many flexicap schemes invest heavily in large-cap stocks. As of June 30, 2024, flexicap schemes had invested 70 per cent of their funds in large-cap stocks. In a broad-based rally, which lifts mid- and smallcap stocks more than largecap stocks, multicap schemes perform better. “By investing in different market caps, multi-cap funds can capture growth opportunities across various sectors and market segments, including emerging companies with high growth potential,” says Khandelwal.

However, in a narrow market led by a few largecap stocks, flexi-cap schemes with high large-cap allocations may be a better alternative. “The disadvantage of multi-cap is the relatively lower flexibility to move across different market cap segments depending on relative valuation,” says Jain.

Who should invest

Investors keen on mid and smallcap stocks but wary of volatility should consider multicap equity schemes over standalone midcap or smallcap schemes. “A multicap fund should be a core product which provides an opportunity for optimal participation at all times,” says Jain.

Invest in these schemes using systematic investment plans (SIP) and systematic transfer plans (STP). “As equity is a growth asset class, a minimum of five years is optimal, as it provides ample time for small and midcap stocks to grow,” says Lodha.