Mutual Funds: Collective wisdom for optimal investing

December 23, 2020 12:45 AM

Two new fund of funds make the most of multi-cap investing, combining active and passive fund management as they track large-cap and mid-cap ETFs

Another AMC has come out with an NFO now.Another AMC has come out with an NFO now.

By Joydeep Sen

The reactions to the Securities and Exchange Board of India (Sebi) mandate that multi-cap funds should invest minimum 25% in each of large-cap, mid-cap and small-cap companies, the subsequent creation of a new category called flexi-cap and the shift of funds to flexi-cap category shows there is demand for funds in this category and the requirement of flexibility.

Multi-cap funds have the second highest AUM, next only to large-cap funds. However, the dilemma for investors remains: Are multi-cap / flexi-cap funds better than index funds or ETFs, i.e., is active fund management better than passive management? The investor also has to decide how much to allocate to large or mid or small-cap or which fund to invest in. Now there is the emergence of a fresh approach to this context.

The new approach
A Fund of Funds (FoF) is a fund that invests in units of other mutual fund schemes. A FoF investing in ETFs or index funds is mostly passive fund management. An ETF or index fund is passive management per se, and the FoF investing in these is offering you a basket. Instead of bothering about which ETF to buy or setting up a trading account with a broker, you simply buy this fund like any other mutual fund. There would be a bit of active management as well, in deciding the allocation between the ETFs in the fund. Thus, these funds offer a combination of active and passive fund management. In a multi-cap or flexi-cap fund, the underlying are the stocks as such; in these funds, the underlying of ETFs or index funds is the via media to the stocks.

The funds available
One AMC came out with its NFO in September, where it uses the “market weight” to allocate to large-cap and mid-cap ETFs. There is an overall capitalisation of the market, and within that, there is a capitalisation of large-cap stocks, mid-cap stocks, etc. The relative ratio of the market cap of large to mid is taken as the ratio for allocation in this fund. Hence this fund is mostly passive management as underlying are ETFs and the allocation ratio is as per the collective wisdom of the market. There is active management as well; when one segment is relatively undervalued, e.g. Nifty Next50, it may allocate a little higher relative to say Nifty50 ETF. The universe of investment for this fund is the top 250 stocks as per market cap.

Another AMC has come out with an NFO now. In this fund, the universe is the top 500 stocks as per market cap. The benchmark for allocation is not the collective market wisdom but the collective fund manager wisdom. It will track multi-cap / flexi-cap funds in the industry and the average allocation ratio to large, mid and small cap stocks will be followed. The collective wisdom of all fund managers is better than one fund manager or investing in one fund. This fund combines active and passive management as the allocation will be tweaked as per changes in the industry allocation, but the underlying is passive. The universe of investment for this fund comprises Nifty100 ETF, Mid-cap150 ETF and Small-cap 250 Index Fund.

Conclusion
Market indices being at all-time high, multi-cap investing makes sense as mid and small cap segments are yet to play out. Investors can avail of these FoFs for easy decision making in the context of active versus passive and allocation to multiple market cap segments. The collective wisdom of the market or fund managers helps in that. The recurring fund management expense ratio is on the lower side. In fact, SIP approach to build your core portfolio is better.

Right strategy

  • Market indices being at all-time high, multi-cap investing makes sense
  • Investors can avail of these FoFs for easy decision making in the context of active versus passive and allocation to multiple market cap segments or fund picking
  • While one NFO is guided by the collective wisdom of the market, the other allocates among large-, mid- and small -cap funds on basis of collective wisdom of fund managers

The writer is a corporate trainer (debt markets) and an author

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