Flexi Cap Funds v/s Multi Cap Funds: Which Is Better at a Market High?

September 23, 2024

Despite the geopolitical tensions (Russia-Ukraine war, Israel-Hamas war, attack by Israel on Lebanon to target Hezbollah, likely escalation in the Middle East, tensions flaring up in the South China Sea between China and Philippines, China and Taiwan, strained US-China relations and trade war, among others), risk of geoeconomic fragmentation, adverse climate events, the risk to the inflation trajectory, tighter financial conditions and interest rates, a high debt-to-GDP ratio of many economies (higher than the pre-pandemic levels in some cases).

All of which ultimately portend strain on global economic growth, the Indian economy has fared well — be it managing GDP growth, inflation, tax collections, fiscal consolidation, and so on.

India is perceived to be a “bright spot” in the global economy and is expected to lead the next decade of economic growth. From being the fifth largest economy (in nominal GDP terms) at present with favourable demographics, strong private consumption, plus public investments, it is estimated to be the third largest by 2027, according to the International Monetary Fund (IMF).

Against this backdrop, and the fact that corporate earnings have been very encouraging over the last few years (more so after the pandemic), the Indian equity markets have also performed very well; created solid wealth for investors. Many of the indices have surged to new highs and the sentiments remain rather upbeat with several IPO and NFOs doing the rounds. No one seems to want to miss the bus, and Indian equities, by and large, are displaying a positive momentum.

Equity mutual funds have successively recorded positive net inflows led by sector/thematic funds, but among the other diversified categories, the Flexi Cap Funds and Multi Cap Funds (along with the rest) have also seen good inflows.

Graph: Flexi Cap Funds and Multi Cap Funds Have Been in the Spotlight in Terms of Inflows

Data as of August 2024
In the case of inflows in sub-categories of diversified equity funds, the segment-wise data reported by AMFI is from April 2019 onwards.
(Source: AMFI, data collated by PersonalFN Research) 

Going by August 2024 data of the Association of Mutual Funds in India (AMFI), Flexi Cap Funds were in the second spot in terms of inflows. Before that in July 2024, it was Multi Cap Funds that received the second-best inflows.

At the lifetime high of the Indian equity market, if you are wondering whether to invest in Flexi Cap Funds or Multi Cap Funds, read on…

So, which is better – Flexi Cap Funds or Multi Cap Funds?

Well, it’s important to first recognise that the surge in Indian equities is largely contributed by mid-cap and small-cap segments of the market, particularly after the COVID-19 pandemic. That said, the large-cap indices have also made considerable progress, significantly contributing to the overall market rally.

This demonstrates that wealth-creation opportunities exist across the market capitalisation segments and there is merit in having exposure to all three market caps. What needs to be followed is an astute and tactical approach when investing.

Flexi Cap Funds

Flexi Cap Funds have a versatile investment mandate. As per SEBI guidelines, Flexi Cap Funds invest a minimum of 65% of their assets in equity and equity-oriented instruments of companies across the market cap range, dynamically, without any upper or lower limit.

Depending on the market conditions, valuations, and liquidity, the fund manager of a Flexi Cap Fund has the flexibility to manoeuvre across large-cap, mid-cap, and small-cap stocks across sectors and themes.

Moreover, the fund manager could increase or decrease holdings within a respective market cap segment, as the outlook alters. This flexibility gives fund managers greater scope to identify attractive opportunities from a large universe of stocks while staying invested.

As you know, the performance of every market cap performance could alter every year. If today it is the small-caps and mid-cap outperforming, tomorrow it could be large-caps. Hence, you cannot skew your portfolio to one or two segments of the market. Diversification remains the cornerstone of investing.

Investing in Flexi Cap Mutual Funds is a great way to diversify your portfolio across market caps and thereby maximise portfolio returns over the long run.

There is scope for the fund manager of a Flexi Cap Fund to generate alpha, i.e. fare better than the benchmark index, thereby rewarding you, the investor, with superior risk-adjusted returns. Moreover, they can potentially generate stable returns across market phases.

Also, compared to Small Cap Funds and Mid Cap Funds — which are very high risk-high return propositions — Flexi Cap Funds offer an acceptable risk-reward balance, potentially mitigate the risk involved better, and thus, usually, are placed lower on the risk-return spectrum of equity mutual funds.

However, given that there is no restriction when taking exposure to large-caps, mid-cap and small-cap, Flexi Cap Funds are riskier than pure Large Cap Funds.

Having said that, historical data reveals that Flexi Cap Funds have predominantly maintained a large-cap biased portfolio at most times.

Multi Cap Funds

Multi Cap Funds, on the other hand, although they have the mandate to invest across market cap segments (large-cap, mid-cap, and small-cap), it is not dynamic.

As per the regulatory guidelines, Multi Cap Funds are mandated to invest at least 75% of their total assets in equities, with at least 25% exposure each in large-cap, mid-cap, and small-cap stocks regardless of market conditions, valuations, and liquidity among the other factors. They are designed to maintain a balance between large-cap, mid-cap, and small-cap stocks, ensuring a diversified portfolio across different market capitalisations.

SEBI came up with this specific definition for a Multi Cap Fund in September 2020, and before that, these schemes invested in multi-caps (large, mid, and small) without minimum exposure to the market cap segments. This was done by SEBI for Multi Cap Funds to prevent over-concentration risk and so that fund houses be true to their label and clearly distinguish from other types of schemes, particularly Flexi Cap.

That said, given that the new definition for Multi Cap Funds by SEBI, offers no flexibility to manoeuvre across market cap segments, there is high risk involved. All that the fund manager of a Multi Cap Fund can do is adjust their portfolios within these limits based on market conditions and opportunities.

During volatile and bearish market conditions, Multi Cap Funds may witness more drawdown than Flexi Cap Funds. This is mainly owing to at least 50% cumulative exposure to mid-caps and small-caps. Conversely, in a broad-based market rally — wherein across the market cap universe equities do well — Multi Cap Funds have shown the ability to outshine Flexi Cap Funds.

Investing in Multi Cap Funds is a great way to get well-balanced exposure across market caps, which helps diversification and helps in maximising portfolio returns over the long run. However, in the short term, particularly when the markets are volatile, the risk could get accentuated for Multi Cap Funds (as the fund manager does not possess much flexibility to swing allocation from one market capitalisation segment to another). But going by past portfolio data, to lower the risk Multi Cap Funds have also held a high allocation to large caps to add stability to the returns.

How Have Flexi Cap Funds and Multi Cap Funds Performed?

The table below reveals the kind of returns Flexi Cap Funds and Multi Cap Funds have delivered across time periods and the level of the risk taken (as denoted by the Standard Deviation) along with the risk-adjusted returns (as denoted by the Sharpe Ratio and Sortino Ratio)

Table 1: Performance of Flexi Cap Funds and Multi Cap Funds

Data as of September 18, 2024
The list of funds cited here is not exhaustive. Only the top 10 funds are considered from each sub-category on 3-year returns.
Returns expressed are rolling returns in % calculated using the Direct Plan-Growth option.
Standard Deviation indicates Total Risk and Sharpe Ratio measures the Risk-Adjusted Return.
They are calculated over 3 years assuming a risk-free rate of 6% p.a.
*Please note, that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, data collated by PersonalFN Research) 

The table above shows that over the last 1 year, certain Flexi Cap Funds, by actively and astutely managing their portfolio, have fared better than Multi Cap Funds.

The rally in mid-cap and small-caps since the lows of the COVID-19 pandemic has helped accentuate the compounded annualised even longer period returns (over 3-yr, 5-yr, and 7-yr) of certain Flexi Cap Funds.

That said, the category average returns of Multi Cap Funds are noticeably higher than those of Flexi Cap Funds across time periods and certain schemes have even outperformed Nifty 500 – TRI by a remarkable margin.

Thus, overall, on a risk-adjusted basis too, as denoted by the Sharpe Ratio (see Table 1), Multi Cap Funds have rewarded investors well for the risk taken.

However, that does not mean that the risk-return is always tilted in favour of Multi Cap Funds.

Table 2A: Performance of Flexi Cap Funds v/s Multi Cap Funds During the Bull & Bear Phases

The list of funds cited here is not exhaustive. Only the top 10 funds are considered from each sub-category.
Returns expressed are point-to-point in % calculated using the Direct Plan-Growth option.
*Please note, that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, data collated by PersonalFN Research) 

Table 2A reveals that when assessed on performance across market cycles, i.e. bull and bear phases of the equity market, Multi Cap Funds could witness more downside than Flexi Cap Funds.

In the recovery phase from the Global Financial Crisis of 2008-09, while Multi Cap Funds on average performed better, in the following bear phase from November 2010 to December 2011, they plunged more. The limited set of pure Flexi Cap Funds then, on average, managed to arrest the downside better.

Table 2B: Performance of Flexi Cap Funds v/s Multi Cap Funds During the Bull & Bear Phases

The list of funds cited here is not exhaustive. Only the top 10 funds are considered from each sub-category.
Returns expressed are point-to-point in % calculated using the Direct Plan-Growth option.
*Please note, that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, data collated by PersonalFN Research) 

In the last bear phase of the COVID-19 pandemic, Multi Cap Funds plunged more than the Flexi Cap Funds (See Table 2B).

In the recent bull phase of the market since the pandemic low, while Multi Cap Funds on average have clocked wanting returns, Flexi Cap Funds, with their active and dynamic fund management style, have rewarded investors with decent compounded annualised returns while effectively managing the risk.

Note, while Multi Cap Funds have clocked higher returns since the lows of the pandemic, now at the lifetime high, the risk is currently on the higher side for these funds given that they have at least 50% allocation held in mid-caps and small-caps.

To Conclude…

Whether you are considering Flexi Cap Funds or Multi Cap Funds for your equity mutual fund portfolio, the key is to choose well-managed ones.

Both Flexi Cap Funds and Multi Cap Funds can form an integral part of your core equity mutual portfolio and may be held in 2024 and beyond, assuming a high-to-very high-risk appetite and investment horizon of 5-7 years.

However, when choosing the scheme, don’t zero in based on past returns as they are not necessarily indicative of how the scheme would fare in the future.

To get a sense of how a scheme would perform in future, evaluate the scheme’s qualitative aspects such as the portfolio characteristics, the market capitalisation bias, investment strategy, liquidity of the portfolio, top 10 stocks in the portfolio, top 5 sector exposure, etc. Plus, it would do well to understand the investment processes and systems at the fund house and the risk management framework in place.

Giving a higher weightage to worthy portfolio characteristics in the scheme selection could potentially reward you well in the long term and help manage the risk well.

In my view, at a lifetime high of the Indian equity market, where valuations in the small-cap and mid-cap segments seem stretched and frothy (BSE SmallCap P/E is nearly 36x and BSE MidCap P/E is 34x), it makes sense to invest in Flexi Cap Fund. Most Flexi Cap Funds are currently holding a dominant portion of their assets in large-caps for stability. The P/E of the BSE LargeCap is around 26x, which is relatively reasonable than the small-cap and mid-cap index.

Owning one of the best Flexi Cap Funds could potentially help limit the downside risk and earn decent risk-adjusted returns. Watch this to know which are the best Flexi Cap Funds for 2024.

If you are a slightly more aggressive investor who does not want to miss out on the wealth-creating opportunity by having at least a cumulative 50% exposure to mid-caps and small-caps, then you may consider a Multi Fund in the core portfolio. But keep in mind that, in case the market corrects from its lifetime high, the drawdown could be higher (than in the case of a Flexi Cap Fund). In the case of a Multi Cap Fund as well, keep a longer horizon of at least 5-7 years.

So, carefully assess your risk tolerance and investment goals before investing. As regards, the question of whether you should make a lump sum investment or take the Systematic Investment Plan (SIP) route, well, either you could make staggered lump sum investments (i.e. invest the lump sum in piecemeal matter) or even better, choose the SIP mode of investing. The latter is particularly prudent and useful when planning long-term financial goals.

If you find it challenging to choose the mutual fund scheme for your portfolio (or any other investment product for that matter), don’t hesitate to seek the help of SEBI-registered investment advisors who can guide you throughout your investment journey.

Be a thoughtful investor.

Happy Investing!

This article first appeared on PersonalFN here