Investment Strategy for 2022: Should you go for Flexi-cap funds or Multi-cap funds?

Flexi-cap funds have the advantage of reducing their midcap / small-cap exposure to zero. In contrast, Multi-cap funds have to maintain a minimum of 25% exposure in midcap and small-cap stocks, which may increase the downside risk and volatility.

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The dynamic asset allocation (DAA) approach can rescue during volatile times.

Tweaking the asset allocation rules for multi-cap funds some time back, SEBI asked the fund managers to be true to their label and have a 25 per cent proportion of mid and small-cap funds as well in the portfolio. Industry experts say this has pushed many multi-cap funds to transform themselves into Flexi-cap funds, in order to retain the higher contribution of the large-cap into their portfolio.

So much so that the net assets under management (AUM) of Flexi cap funds stood at Rs 2,14,649.76 crore at the end of November. In comparison, multi-cap funds managed a net AUM of Rs 31,543.38 crore.

Even though the Flexi cap funds were seen better placed to handle market volatility, multi-cap funds have outperformed Flexi cap funds in 2021. Experts say this is majorly attributed to the run-up in small and mid-cap stocks. Flexi cap funds offered an average return of 31.89 per cent in 2021 compared to 40.92 per cent returns posted by the multi-cap category. 

Prashant Joshi, Co-Founder and Partner, Fintrust Advisors says, “Though this time market has performed in favour of Multi cap funds, during the volatile time when the quality and strength of the business offer the required cushion, Flexi cap funds with a higher contribution of large-cap stocks may perform better.” The topper in the Flexi cap category offered 48.73 per cent returns in 2021, compared to 67.86 per cent returns by the topper in the multi-cap category.

Joshi explains “The equity market recent rally, which is more pronounced in mid & small-cap, and the expectations of tighter monetary or fiscal policy across the globe can cast a shadow on equities markets. In case of downturns, the mid & small are more sensitive to the vagaries of the markets, exhibit high volatility, and may have more significant drawdowns.” 

He further adds, “In such a scenario, Flexi-cap funds have the advantage of reducing their midcap / small-cap exposure to zero. In contrast, Multi-cap funds have to maintain a minimum of 25 per cent exposure in midcap and small-cap stocks, which may increase the downside risk and volatility.”

Will more multi-cap funds transform into flexibility caps?

According to Joshi, there may be more Multi caps funds offerings in the future. Multi caps have their advantages as they provide diversification across market capitalisation. “A Multi-cap fund allows the fund manager to adjust the market cap curve allocation in line with the economic and earnings cycles, offering better risk-adjusted returns in the long term,” adds Joshi. 

How should one go about asset allocation during the volatile period?

The dynamic asset allocation (DAA) approach can rescue during volatile times. Having said that, experts point out it must match the risk profile of an investor. It involves adjusting asset allocation across various asset classes and sub-asset classes basis the opportunity provided, volatility exhibited and correlation, to suit market conditions. 

It also helps to reduce the risk and mitigate volatility at the portfolio level, and reap the benefits from opportunities provided by the various asset classes. “Reducing equity exposure and increasing debt when equity markets are expensive, and vice versa is an example of DAA. Shifting allocation to large-cap from mid and small caps basis the risk-reward expectations is an example of sub-asset DAA,” adds Joshi. 

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