Imagine how comfortable it would be if you had an umbrella that gave you shade on a hot day and warmth on a cold day. The multi-cap fund is such an umbrella for your portfolio. It gives you shade with the stability of large-cap stocks when market is over-heated and the warmth from the growth possibilities in mid- and small-cap stocks when the opportunity is right. Multi-cap funds are the biggest winners post the recategorization of schemes. They have the flexibility to diversify and seek investment opportunities across market capitalizations—large, mid or small.

The sale pitch of the multi-cap category is as one that will orient and position the portfolio to benefit from the segment of the market that will outperform. The flexibility in portfolio construction means that not all multi-cap funds are the same. What you can expect from the fund in terms of risk and return will depend upon how the fund manager has interpreted the multi-cap mandate. We looked at the portfolios of multi-cap schemes to identify the different styles adopted. The common thread is the flexibility that the fund managers have to seek investment opportunities across market capitalization and sectors. But beyond this, there are nuances adopted to construct portfolios that give them a distinct character. Here are the five styles we found.

Large-cap focus

Most funds in the multi-cap category peg the portfolio in the large-cap space and then drift downwards depending upon the philosophy of the fund. The funds focus primarily on the selection of stocks based on its fundamental worth and use the multi-cap tag for exploring investment opportunities across the large, mid- and small-cap space. “Find strong businesses with scalability and then confirm with good management and balance sheet." This is the mantra that the Aditya Birla Equity Fund follows. “The focus is on giving investors a smooth ride with stable and consistent returns. If you chase market segment valuations then good markets will see a steep rise but the drawdown will be as steep too, especially in the mid- and small-cap segment," according to the team at the Aditya Birla Sun Life Equity fund.

These funds invest with a long-term perspective. The low portfolio turnover ratio is a reflection of this strategy. “It is important to give 18-24 months for the business to realize potential and iron out cycles. Business conditions keep changing. If things are not going as per plan, then we consider exiting," said the Aditya Birla team. 

Investors in such funds should have a clear investment horizon of 3-5 years to allow the investment rationale to play out and enjoy a complete cycle. Over the 3, 5,7 and 10-year investment horizons funds such as the Aditya Birla Equity fund, Kotak Standard Multicap fund, Mirae Asset India Equity fund have been top quartile performers. 

Mid- and small-caps

There are some funds that have a significant mid- and small-cap focus in their portfolio, even when this segment is seen as over-valued or riskier. The Principal Multi-Cap Growth fund limits the large-cap exposure at around 50%. “The fund believes in seeking the best opportunities wherever they lie," said P.V.K. Mohan, head-equities, Principal Mutual Fund. “We believe well-run scalable businesses in the mid- and small-cap segment stand a better chance of beating the Nifty in the long run," he said. “The appeal in this segment is that you can identify fast growing, niche businesses at attractive valuations," he added. The fund does do some tactical shifting among market segment to protect downside. The large-cap segment that was not more than 45% in 2017 was raised to 60% by booking profits in some of the mid-cap stocks. It uses cash tactically to benefit from any mispricing in volatile markets but does not take cash calls. 

Some of these funds stay in the small- and mid- cap segments perhaps as legacy from their earlier avatar as mid-cap or small-cap funds. These are the funds that choose to stick to a preferred mid-cap allocation and not move to large-caps or even cash during downside. Taher Badshah, CIO-equities, Invesco Mutual fund defines the multi-cap mandate as one that allows you to include the stability of large-caps, growth of mid-caps and the future opportunities in the small-cap space. The fund follows a growth strategy and has set internal limits on large-cap stocks at 50% to give adequate growth impetus to the portfolio from the mid- and small-cap segments. A tight portfolio of not more than 40 stocks and taking overweight positions is the strategy to generate alpha. 

These funds believe in a buy and hold approach that is reflected in the low portfolio turnover. They are willing to take some short-term pain for long-term gains and stay with their stock picks. While the returns from the funds following this style have kept pace with other multi-cap funds over the three-year, five-year and ten-year investment periods, the annual returns show steeper drawdowns. Sign on if you are ready for a choppy ride and have 3-5 years for the growth opportunities to be realized.

Market-cap swingers

Then there are funds that interpret the multi-cap mandate as swinging the portfolio to take advantage of the segment—whether large, mid or small—that is expected to outperform. To a large extent these funds too remain pegged in the large-cap space, with exposure to the mid- and small-cap segment seeing shifts based on how the segments are expected to perform. The high portfolio turnover ratio in such funds reveals their strategy of swinging between market segments.

“The relative valuation between the large, mid- and small-caps drives the portfolio decision in the Prudential ICICI multicap fund," said Chintan Haria, head–product development and strategy, ICICI Prudential Asset Management. But it does not believe in taking undue risks. “The fund may have lost on some upside in 2017 as it took a view to pare exposure to the mid- and small-cap segments that were seen as overvalued and moved to large-cap by the year end." The fund also keeps away from momentum driven stocks. A reason why funds are not able to move quickly to exploit a run-up in the mid- and small-cap segment are the liquidity constraints that characterize these segments, said Haria. 

A careful sector analysis, bottom-up stock selection at appropriate valuation and close watch on corporate governance are risk mitigating portfolio building steps for this fund. Funds following this style have to tick multiple boxes. First, judge the comparative valuations of the segments, then time entry and exit to give the desired segment focus to the portfolio, and find good investment options. It is difficult to get all of them right all the time. Investors need to select fund managers with proven record in navigating market cycles and be comfortable with the risk management strategy.

Focused multi caps

These funds build focused portfolios from investment opportunities across the market capitalization spectrum. However, this category too finds its investment picks primarily in the large-cap segment. Gautam Sinha Roy, senior vice president and fund manager, Motilal Oswal AMC, attributes this to the liquidity constraints in the mid- and small-cap segment. “As the fund size grows, finding liquid investment opportunities in the mid- and small-cap space is difficult as the stock holding is likely to be high in a concentrated portfolio," he said. This explains the large-cap bias in this subsect of the multi-cap fund category. The returns may see a divergence from the index returns, particularly in the shorter evaluation horizons of up to a year. “The overlap with index is low," said Roy explaining the reason for the deviation with index returns. Over longer investment horizons, these funds have been able to generate significant alpha. The Motilal Oswal 35 fund is among the top quartile performers in the 3-year investment horizon, while the Axis Focused 25 takes the top spot in the 3-year period. Invest with a long-term investment horizon even if the fund's performance  diverges from that of the benchmark in the shorter evaluation periods. The common thread in all the funds, apart from being market-cap neutral is that they don’t see moving into cash as a source for generating alpha. But there is at least one scheme in this space that has done it. 

Multi asset multi cap fund

Parag Parikh Long Term Equity fund does not believe in deploying funds unless the valuations are good, said the spokesperson for the fund house. This has meant that the fund was in cash at the time of the market correction this year and benefitted from it. It is the only one in this space that provides geographical diversification. It maintains a 65% exposure to Indian equities and invests up to 35% in overseas equity. The fund does adequate due diligence and adopts a bottom-up stock picking strategy, both in the domestic and overseas markets. As befits a multi cap fund, its stock selection decisions are market-cap neutral and looks for strong stocks at good valuations. Investors should have a 3-5 years horizon to benefit from its strategy, said the fund’s spokesperson.

Mint money take

The opportunity to make the most of the equity offerings available across the market is the reason why the multi cap segment becomes an integral part of most portfolios. Take the time to understand the style and strategy adopted by the funds so that the risk and return features of the fund is a good fit with the rest of the portfolio.

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