Largecap & flexicap funds: Do you need one, or both, in your portfolio?

With flexicap funds, one can diversify across companies with different market capitalisations.

The two dominant categories of equity funds are largecap funds and flexicap funds. Most investor portfolios have at least one scheme from either category.

But given the similarities in how, at times, both are managed by the same fund manager (more about similarities in a bit), is there really a case for having schemes from both categories in your portfolio? Or is it enough to have funds from just one category?

But first, let’s see what sets the two categories apart.

Largecap funds vs. Flexicap funds 

Largecap funds invest a minimum of 80 percent of its corpus in largecap stocks (i.e., in the top 100 listed stocks). So, if someone wants to have equity exposure only to a few of the largest Indian companies, investing in largecap funds would serve the purpose.

Within this category itself, there are active funds and passive index funds (besides exchange-traded funds or ETFs). Over the last few years, the number of active funds that have consistently beaten the index have reduced. And even for those that managed to achieve this feat, the margin of outperformance has been going down. I have written about this earlier as well that for allocation to largecap stocks now, it’s best to go for passive largecap index funds and not active funds.

Flexicap funds, on the other hand, have the flexibility to invest across stocks from different market capitalisation categories without any minimum or maximum restrictions. So, a flexicap fund manager has the freedom to invest any proportion of the fund‘s portfolio in stocks from large-, mid- and smallcaps. This means that with one flexicap fund, one can diversify the investment across companies with different market capitalisations.

Also see: Moneycontrol's MC30 List of funds

Are flexicap funds really acting right? 

This is where one needs to look under the hood of flexicap funds. While largecap funds have to mandatorily invest a minimum of 80 percent in largecap stocks, flexicap funds don’t have any such restrictions. But a vast majority of flexicap funds have a very high allocation to largecap stocks ― 60 percent to almost 75 percent in a few schemes.

Note - You can check marketcap allocation of flexicap funds on Moneycontrol’s MF tool here. 

While one reason for this can be that those fund managers ‘currently’ view this as the right thing to do, given market conditions (that is, in their view, largecaps may be better placed than mid- or smallcaps), the fact is that in the past too, largecaps have received a majority of the flexicap’s assets under management (AUM) allocation. So, a more consistent justification is that many flexicap funds have grown so large that there is no other way for them to deploy so much AUM without disrupting the prices of mid- and smallcap stocks. Hence, they tilt towards largecaps.

So, while flexicap managers have the flexibility to move across marketcaps in search of higher returns and lower risk, the fact is that they cannot do it so nimbly as it may seem to the uninformed. As a result, many flexicaps operate as pseudo largecap funds.

However, this is not true for all. Many flexicap funds have a decent allocation to mid-small caps and follow genuinely different investment strategies and with unique styles.

Also read: How flexi cap became the largest category in equities in 2022

Suitability 

For investors who only want exposure to largecap stocks, it’s best to stick with largecap funds. Active vs Passive is another topic of discussion, but my recommendation is to go for passive largecaps instead of active ones.

Flexicap funds have the freedom to invest across marketcaps. The fund manager can opportunistically move around for better returns. So, investors who, in addition to large exposure, also want exposure to potentially high-return mid- and smallcap stocks, can consider flexicap funds.

Also read: Mutual funds increased exposure to these sub-sectors lately. Do you own any?

Conclusion

- Conservative investors who need to have small equity allocation, can take equity exposure via largecap funds. They don’t need to invest in flexicap funds.

- Balanced investors can have both. There will be obvious overlaps in the portfolios, but that is fine. You will have high exposure to largecaps (due to the pure largecap fund and largecap portfolio of the flexicap fund) with a flavour of mid-small caps (via flexicap fund).

- If you are an aggressive investor, then having flexicap funds and skipping largecap funds is acceptable as well. Though, having both is not wrong either.

- Different flexicap funds follow different styles. So, one can have up to two flexicap funds in the portfolio. For small portfolios, just one from the category is enough.

- You don’t need more than one largecap fund. Pick from passive or active, but just one is enough for most people.

- For your retirement goal, I suggest having a dedicated largecap index fund. The reason is that due to its active nature, your chosen flexicap fund may do well for a few years and then wither away. You will have to replace it with another flexicap soon. To avoid churning the entire portfolio, it is better to have an allocation fixed for index funds which do not need to be replaced for underperformance as they mimic the returns of the index.

Also read: Where to invest Rs 10 lakh today? Don’t lose faith in US tech stocks, says Rajeev Thakkar of Parag Parikh MF