What's behind the contrasting investment trends in multi-cap and flexi-cap funds?

Mutual fund houses in India have increased their focus on multi-cap funds in the recent past.

Multi-cap and flexi-cap funds, which invest across large-cap, mid-cap and small-cap stocks, have been witnessing contrasting trends in investments over the past three months.

As per Association of Mutual Funds in India (AMFI) data for July, multi-cap funds witnessed net inflows worth Rs 2,500 crore while flexi-cap funds saw outflows to the tune of Rs 932 crore.

Further, over the last three months, multi-cap funds have seen investments of Rs 3,340 crore while flexi-cap funds saw net selling of Rs 1,317 crore.

Both multi-cap and flexi-cap funds work under the same mandate of investing across market capitalisations, albeit to different degrees. What’s behind the difference in their fortunes?

New funds

Mutual fund houses in India have increased their focus on multi-cap funds in the recent past. Data available with AMFI shows that over the last year, there have been seven new fund offers (NFOs) of multi-cap funds, and four of flexi-cap funds. But why is that?

In 2020, the Securities and Exchange Board of India (SEBI) introduced new norms for multi-cap funds, mandating a minimum of 25 percent allocation each to large-, mid-, and small-cap stocks.

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Soon after, the capital markets regulator launched a “flexi-cap" category, which didn’t have restrictions on investing in large-, mid-, or small-cap stocks.

Consequently, most funds moved to the flexi-cap category, while a few remained multi-cap.

Today, there are 33 flexi-cap funds while the count of multi-cap funds increased to 18 as of July, with new fund launches.

Data shows that since January 2023, NFOs of multi-cap funds have collected total funds of Rs 4,439 crore, while flexi-cap NFOs have raised Rs 964 crore.

The multi-cap fund launches is one reason behind positive inflows into this category.

Allure of smaller-caps

Data shows that on an average, flexi-cap funds combined are 23 percent into mid-cap and small-cap stocks, against 55 percent by multi-cap funds.
This higher exposure to smaller-caps has resulted in a better performance by multi-cap funds.

Data shows that over the past year, while flexi-cap funds have risen 15 percent, multi-cap funds have gone up 20 percent, resulting in higher investor interest in the latter category.

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“The performance that mid-cap and small-cap spaces have given predominantly post COVID is probably prompting a lot of investors to consider multi-cap funds,” said Harshad Chetanwala, co-founder of MyWealthGrowth.

Mind the risk

On the face of it, the multi-cap and flexi-cap categories might look similar as they both invest across large-, mid-, and small-cap stocks. However, the regulatory mandate on their exposure to different market-caps makes them very different and changes their risk profiles.

“There is no comparison between a flexi-cap and a multi-cap fund. Flexi-cap funds are pseudo large-cap funds, with one or two exceptions. On the other hand, multi-cap funds are a pure market-cap diversification category,” said Kirtan Shah, founder of Credence Wealth Advisors.

In the flexi-cap category, fund managers have the flexibility to change market-capitalisation exposure based on their view of where the market is heading, an option that is not available to multi-cap funds.

“This increases the risk element. In the last few years, mid-caps and small caps have generated better returns, but these are the places where the volatility could also be higher, plus large-caps are more or less stable. Further, I don't see interest in the flexi-cap category from investors reducing,” said Chetanwala.

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Meanwhile, Shah suggests that most investors need to stick to the large-cap and flexi-cap categories. “If at all somebody has some risk appetite, some allocation to information technology, pharma and BFSI (Banking, Financial Services and Insurance) funds will do well,” he added

Keep in mind that in any circumstance, a 50 percent combined allocation in mid-caps and small-caps would be riskier than a flexi-cap fund and even a large and mid-cap fund.

What should you do?

Whether you should invest in a multi-cap or a flexi-cap fund, depends on how your overall portfolio looks like. If you have a sizeable allocation to large-cap oriented funds (this would include index and exchange-traded funds too), then you can take an exposure to multi-cap fund. This ensures that by discipline, you would have a foothold in small- and mid- cap category. But if you are a first-time investor and would like to skip the large-cap category altogether (since large-cap funds have been finding it difficult to beat benchmark indices these days), then start your investment journey in a flexi-cap fund. In this case, you might want to skip the multi-cap category and then hop over straight to small- and mid- cap funds for a meaningful exposure across all market capitalisation stocks.