Mutual funds are a boon to an investor who does not understand the market or have the time to follow the prices and want to diversify the risk among multiple stocks. A vast majority of funds have helped its investors by beating their respective benchmark returns and hence investors rejoice over not spending time on stock selection and frequent buy sell transactions. Above all, risk reduction is a key determinant in deciding to invest in a mutual fund.
Most of the MF schemes invest in more than 20-25 stocks. The schemes are categorised as Large cap, Mid cap, Small cap, Multi and Flexi cap, Theme funds, Sector funds etc., based on the size of companies invested and objective of the scheme. If one were to plot a graph comparing risk and return, Large cap funds bear the least risk and risk increases through the categories till Sector funds which are the riskiest. Multi cap and Flexi cap funds are the most diversified and bear average risk among the equity oriented funds.
Mutual funds itself feature diversification. By choosing stocks from across market caps and sectors, multi cap and flexi cap funds yield a diversification multiplier effect. They feature diversification within diversification. These funds do not carry stock selection restriction as in specific category funds where they cannot pick stocks outside the allocated basket (A top 100 fund ideally cannot pick the 101th stock into its portfolio). So, the whole spectrum of listed stocks are open before a multi cap fund manager to choose from, which in turn minimizes the risk. Hence, for a new investor, it is always recommended to start with multi cap funds. And for any layman investor for that matter, it is advisable to invest at least 60% of their equity oriented investments in multi cap funds.
As we have dynamic bond funds measuring the expertise and ability of a fund manager in the debt category, multi cap fund managers confront the most challenging task of outperforming the market beta returns by building the right allocation mix across market caps. The following table depicts an interesting statistic of SIP returns of a few Multi cap and Large cap funds over the past 10 years. The top positions are held by prominent multi cap schemes of the market.
(The author is Vijayanand Prabhu, investment analyst, Geojit BNP Paribas)