Flexicap or multicap funds? How to make the right choice

Multicap funds are required to invest a minimum of 25 percent each in large, mid and smallcaps. So, irrespective of fund managers’ view, these funds are structurally forced to have at least 25 percent exposure to each market-cap segment. But once an allocation of a minimum of 25 percent each is reached, the fund manager is free to deploy the residual 25 percent at their discretion. So, a multicap fund can have 33.33 percent in each segment. Another multicap fund can also have 50 percent in large-caps and 25 percent each in both mid and smallcaps. So flexibility is there, but only for the last 25 percent part.

Interestingly, and unless you failed to notice, this 25-25-25 rule also forces multicap funds to have a combined allocation of at least 50 percent to the riskier mid-&-smallcaps bucket. We will come back to this in a bit.

Flexicap funds, on the other hand, are true to their name. The fund managers have complete go-anywhere flexibility to where they decide to invest. There are no percentage-based restrictions on market-cap allocations. Also, based on their changing views/strategy, they are free to opportunistically move between the three segments without restrictions.

Allocation under both categories

Here is the latest average allocation of the fund categories to different market segments currently:

And if we further drill down individual fund data, then it becomes clear that barring a few schemes, most flexicap funds are largecap heavy. I will not want to label them as index-huggers or pseudo largecaps, but over the years, it is clear that most of them tend to be run like largecap funds.

Multicap funds, on the other hand, given the structural mandate, offer true diversification with a minimum 25-25-25 allocation.

Is it because of the choice of benchmarks chosen for each category?

The benchmark for the flexicap category is Nifty500 TRI. This index easily has more than 70 percent allocation to largecaps. So most flexicap schemes tend to move around that kind of largecap allocation. The multicap category has a different benchmark - Nifty 500 Multicap 50:25:25 TRI, which has 50 percent allocation to largecaps and 25 percent each to mid and smallcaps. Schemes in multicap funds are generally handled in a similar fashion.

So one of the reasons why flexicap funds are managed the way they are may be because of the choice of benchmark they are trying to beat. And due to that, even though they are ‘flexi’ble enough, they still need to move in accordance with the benchmarks they are compared with.

Also see: Nifty50, Nifty100 or Nifty500: Which index gives you the best diversification?

Normally, a flexicap fund would seem like a better choice given its in-built flexibility and potential to do better than multicap funds which are structurally bounded. However, the reality is different as we saw in the allocation of flexicap funds.

Choosing between the two

·         If one wants to maintain at least a bare minimum level of exposure to all market-cap segments via just one fund, then multicap funds are suited due to their minimum 25-25-25 rule.

·         But this also means that a multicap fund will always have a minimum of 50 percent allocation to mid- and small-cap segment. And these stocks, can be very volatile periodically and hence, may not be suited for everyone.

·         If you want to bet on a fund manager’s ability to decide what is the best allocation to different market-cap segments (and not be restricted by any rules), then flexicap funds are a better choice. Here the fund manager has the freedom to assess different companies and invest in them regardless of their market caps.

·         As they hold more largecap stocks, most flexicap funds tend to be less volatile, especially during market falls. Due to higher (minimum 50 percent) exposure to the mid & smallcap segment, multicap funds come with higher volatility during such periods of fall.

·         If you already have a big enough allocation to largecap funds in your portfolio, then you can go for multicap funds as they have a much bigger allocation to non-largecaps.

·         In general, there is no need for having both funds if you have a common mutual fund portfolio for all goals, even though both aim for inflation-beating growth in the long term. However the choice between flexicap or multicap funds should be made after you look at your existing MF portfolio.

Also see: Which equity fund categories should you invest in?