What is the difference between Multi cap and Flexi cap Mutual Funds

Multicap funds are diversified equity mutual fund schemes which invest across market cap segments i.e. large cap, midcap and small caps. Multicap funds have historically been one of the most popular mutual fund categories among investors in India.

In November 2020, the market regulator SEBI introduced a new fund category called Flexicap funds and made some fundamental changes in the scheme mandates for Multicap funds. In this blog post, we will discuss about Multicap and Flexicap funds, and how investors can make informed decisions about investing in these two fund categories.

Different market cap segments

Before we discuss about Multicap and Flexicap funds, it is important to recall the three market capitalization segments in the equity market:-

1. Large cap: According to SEBI, the largest 100 companies by market capitalization are classified as large cap companies.


2. Midcap: SEBI categorizes 101^st to 250^th companies by market capitalization size as midcap companies. There are 150 midcap stocks.


3. Small cap: 251^st and smaller companies by market capitalization are classified as small cap companies by SEBI.

Historical background of multicap funds

Though the “Multicap” became a formal equity fund category vide SEBI’s circular on “Categorization and Re-classification of Mutual Funds” in October 2017, schemes with multicap characteristics have existed for more than 25 years now. These schemes would invest across market cap segments and had the flexibility to change market cap allocations according to the fund manager’s outlook. In bull markets, these schemes would increase their mid and small cap allocations, while in bear markets they would reduce mid / small caps and shift towards large caps.

These schemes were very popular with investors because they could give superior returns compared to large cap funds over long investment horizons and at the same time saw lesser drawdowns compared to midcap funds in volatile markets. If we look at category wise AUMs of equity funds, these funds had similar, if not higher, share of total AUM as large cap funds. In 2017, SEBI formally introduced the multicap category. Unlike large cap, large and midcap, midcap and small cap funds, multicap funds had the flexibility to invest any percentage of their assets in any market cap segment. There was no upper or lower limit for any market cap segment, as long as total equity allocation was at least 65%.

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What change did SEBI make in November 2020?

In November 2020, SEBI changed the fundamental attributes of multicap funds. As per SEBI’s new mandate, multicap funds had to invest at least 25% of their assets in each of the three market cap segments viz. large cap, midcap and small cap.

So multicap funds will have to invest minimum 25% of its assets in large cap, minimum 25% in midcap and minimum 25% in small caps. The balance 25% (after allocation of 25% each to large, mid and small caps) can be invested in any market cap segment or any asset class.

SEBI also introduced a new category called Flexicap funds, which had the flexibility to invest across market cap segments without any limits. In other words, the mandate of flexicap funds is the same as what it was for multicap funds prior to SEBI’s change in November. The response of many Asset Management Companies to SEBI’s move was to simply rename the multicap funds as flexicap funds. For investors of these multicap funds (which became flexicap funds), there was no change in the fundamental investment strategy of the fund. Some AMCs however, did not change their multicap funds to flexicap funds. Instead they made changes to the fundamental attributes of the scheme to reflect SEBI’s new mandate for multicap funds.

Why did SEBI make this change?

According to SEBI, this change was required to make multicap funds true to label. The name multicap should reflect the multicap nature of the scheme portfolio holdings. For example, if 80% of a scheme’s holdings are large cap, then a scheme should not really be called a multicap fund. Ever since midcaps and small caps started correcting in 2018, many multicap funds started shifting their portfolio allocations towards large cap. As a result, over a period of time, many multicap funds started resembling large cap funds. That is why, this change was necessary, so that investors could make informed investment decisions.

Fund managers of many multicap schemes were uncomfortable allocating a large percentage of their assets to mid and small caps. They also wanted the flexibility to manage asset allocation according to their market outlook. SEBI took cognizance of the concerns and views of fund managers / asset management companies, and introduced the category flexicap funds. Flexicap funds are true to label as they have the flexibility to invest across market cap segments. Another reason why SEBI made this change was to provide liquidity in the small cap segment of the market.

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How to invest after this change?

We, in Advisorkhoj, are of the opinion that this was a good move on part of SEBI as it provided clarity to investors about the risk / return characteristics of their investments and invest according to your risk appetite and investment needs:-

• If you want to invest primarily in large caps due to your risk appetite, you should invest in large cap funds and notmulticap funds.


• If you want to invest in different market cap segments, then you can invest inmulticap funds. Since multicap funds have significant allocations to mid and small caps (minimum 50% allocation to mid and small caps), you need to have high risk appetites and long investment horizons. However, multicap funds have the potential of giving superior returns compared to large cap funds, over long investment horizons.
  
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• If you are not sure which market cap segments are suitable for your investment needs and want your fund manager to decide in which segments to invest according to market conditions, then you can invest in flexicap funds.

Multicap or Flexicap funds

There are lot of blogs on digital media on the merits / demerits of multicap versus flexicap funds. Many of these blogs have taken a view based on perceived risk profiles of multicap and flexicap funds. In our view, every investor is different; you should consider the following factors and make informed investment decisions:-

• The most important factor is your risk appetite and investment needs. You should also take into consideration your current asset allocation and what your target asset allocation should be.


• You can invest in multicap funds if you are comfortable with minimum 50% allocations to mid / small caps and minimum 25% in small caps. The large cap allocation of multicap funds, will limit downside risks in volatile markets.


• You can invest in flexicap funds if you want to rely on and have confidence in the fund manager’s ability in taking asset allocation calls based on market situation and his / her outlook. You should invest in schemes whose fund managers have strong long term track record across different market conditions.


• Fund managers are human and they may make errors in judgement. There are funds which employ quantitative (based on mathematical models) flexicap strategies to decide on market cap allocations. They aim to take human judgement out of the investment process. Some funds may use passive investments (indices) to minimize unsystematic risks, along with quant strategies.

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Conclusion

Though multicap and flexicap funds may seem similar to many investors, there are important differences between the two.

SEBI’s very purpose of creating different mutual fund categories is to provide more clarity to investors and help them make informed investment decisions. Different investors have different risk appetites, investment needs, experience, knowledge and preferences. Flexicap funds are not better than multicap funds or vice versa. Multicap and flexicap funds are suitable for different types of investors. We have also discussed how you can make informed investment decisions based on your needs. As always, you should consult with your financial advisor to have a better understanding of different mutual fund products and invest according to your needs.