Here’s Why Investing in Equities Through Flexi-cap Funds Makes Sense Now

November 24, 2021 Mutual Fund

Flexi-cap Funds is an equity mutual fund category that has the flexibility to invest across market cap segments viz large-cap, mid-cap, and small-cap without any upper or lower limit. This multi-cap strategy provides fund managers with more leeway in building the portfolio.

The Flexi-cap Funds category has gained lot of attraction among investors in the last few months as it allows investors to diversify their investment portfolio across market caps. Consequently, the category has witnessed massive inflows; its asset size is now second only to the Large-cap Funds category.

Does investing in Flexi-cap Fund makes sense now?

After witnessing a stellar broad-based rally since March 2020, the Indian equity market has turned volatile and lost some steam in the past few weeks. The Nifty 500 index is now down by around 6% from its peak (as on November 22, 2021). Though economic activities have revived, there are concerns about stretched valuations and sustainability of corporate earnings.

Moreover, global cues continue to be weak amid inflation fears and resurgence of COVID-19 in some of the European countries. The market is likely to witness further correction as investors start shifting their focus from momentum to quality stocks.

Graph 1: The Indian equity market has lost some steam in the past few weeks

Data as on November 22, 2021
(Source: ACE MF, PersonalFN Research)  

In such market conditions, it is important to maintain a diversified portfolio of stocks spread across market caps. As you may be aware, companies belonging to different market caps usually vary in performance over certain time periods. Therefore, diversifying your investments across market caps, preferably through a Flexi-cap Fund, can reduce portfolio risk and mitigate volatility, thereby maximizing portfolio returns over the long term.

Depending on market conditions, liquidity conditions, and valuations, the fund manager of a Flexi-cap Fund can manoeuvre among different categories of market cap. This gives fund managers greater scope to identify alpha-generating opportunities from a large universe of stocks which can reward investors with superior risk-adjusted returns over the long term.

[Read: Multi-cap Fund v/s Flexi-cap Fund: Which is a Better Fit for Your Portfolio?]

Graph 2: Diversification across market caps enables you to earn optimal risk-adjusted returns

*YTD as on November 22, 2021
(Source: ACE MF, PersonalFN Research)  

Flexi-cap Funds have the flexibility to even reduce the exposure to riskier segments such as small-caps and mid-caps to zero if the situation so requires and simultaneously increase exposure to large-caps. Such flexibility coupled with the higher large-cap allocation can aid in stabilizing the portfolio during bearish market phases. In addition, managing liquidity challenges associated with mid-caps and small-caps becomes easier for fund managers in case of Flexi-cap funds.

Meanwhile, if the broad-based market rally continues and mid-cap and small-cap stocks continue to soar higher than large-cap stocks, Flexi-cap Funds can increase their exposure to mid-cap and small-caps and benefit from its high growth potential.

The freedom to dynamically manage allocation in the large-cap, mid-cap, and small-cap segment enables Flexi-cap funds to offer investors a better mix of growth and value stocks.

How is the performance track record of Flexi-cap Funds?

Though Flexi-cap Funds is a recently launched category, many funds in the category have been in existence for a very long time under the erstwhile Multi-cap funds category. Now classified as Flexi-cap Funds, these funds continue to follow their old investment strategy because it offers complete flexibility for the fund while investing across market cap segments. Hence, the recategorization did not have any significant impact on the way mutual fund houses manage these schemes.

Flexi-cap Funds have generated consistent returns for investors during both upside and downside market conditions. In the last 1-year, 3-year, 5-year, and 7-year period, Flexi-cap Funds have generated returns of 43.55% (Absolute), 21%, 18%, and 13.4% (compounded annualised) respectively, as on November 22, 2021. Moreover, it has outperformed the Large-cap Funds category that too at a reasonable level of risk.

Notably, Mid-cap Funds and Small-cap Funds have outperformed Flexi-cap Funds and Large-cap Funds by a wide margin in the last couple of years. However, since Mid-cap Funds and Small-cap Funds have a mandate to invest minimum 65% of its assets respectively in mid-cap and small-cap stocks, there is high risk associated with these schemes.

Table: Performance of Flexi-cap Funds in the past market cycles

Data as on November 22, 2021
(Source: ACE MF, PersonalFN Research)  

As you can see in the table above Flexi-cap Funds category may not outperform the broader Nifty 500 – TRI index during bullish phases. However, they can generate reasonable returns in line with the benchmark. This is because most funds in the category maintain a large-cap biased portfolio at all times to reduce the impact of any potential volatility and benefit from the stable growth that it provides. On the other hand, the category can efficiently contain the downside risk during bearish market phases by reducing exposure to riskier segments.

Even at times when the overall stock market is not performing well there are certain segments/sectors that may be doing well. Thus, due to its flexible investment mandate, Flexi-cap funds can identify such opportunities and deliver steady returns across market phases.

Who should invest in Flexi-cap Funds?

The equity market volatility could intensify in the near future. Investors who do not have a very high risk profile can consider booking profits in riskier categories like Mid-cap Funds and Small-cap Funds and deploy the proceeds in less risky avenues such as Flexi-cap Funds.

But ensure that the fund’s objective aligns with your financial goal, risk profile, and investment horizon. Flexi-cap funds are suitable for investors looking to invest in a large-cap oriented fund along with tactical allocation to mid-cap and small-cap stocks. You should invest in this category only if you have investment horizon of at least 5 years.

Since the performance of a flexi-cap fund depends on the fund manager’s ability to timely identify attractive opportunities from a large universe of stocks, selecting a worthy Flexi-cap scheme is crucial. Avoid selecting schemes in the category based on its short term performance.

Ensure that you invest in worthy schemes after evaluating its long term performance on various qualitative and quantitative parameters. When you invest in Flexi-cap Funds prefer the SIP mode of investment to mitigate the impact of volatility and benefit from the power of compounding in the long run.

This article first appeared on PersonalFN here