One of the basic equity funds that many advisers and distributors tell people to buy is a multi-cap fund. It is, in the truest sense of the word, a diversified equity fund because it aims to invest across stocks and sectors, and also in companies of different sizes: large, medium and small. But that also makes a comparison between two multi-cap funds a bit tricky. You should know that one multi-cap fund can be vastly different from another.
How much a multi-cap fund invests in large-, mid- and small-cap companies depends on its fund manager. If the equity market has fallen a lot and is at a bottom, according to the fund manager, then she may consider increasing the scheme’s exposure to small- and mid-cap stocks. Typically, when equity markets rise, the small- and mid-caps rise first and faster. But if equity markets have risen enough already and valuations seem expensive—like many experts describe the current market situation as—then typically multi-cap fund managers tilt their portfolios towards large-cap stocks. Some fund managers may even avoid small-cap stocks altogether or keep their exposures low.
According to Value Research data, out of 59 multi-cap funds, 45 schemes had less than 10% of their respective overall portfolios in small-cap scrips. But a fund that invests, say, 7-10% in small-cap scrips can also behave very differently from one that doesn’t have any small-cap scrip. Presence of small-cap scrips in a fund’s portfolio makes the portfolio more volatile. Of course, the potential of returns increase but so does the risk.
Distributors say that if a fund manager can manage the risk, there's nothing wrong with a multi-cap fund holding such scrips. Some advisers, however, said they avoid those multi-cap funds that have a tilt towards small- and mid-sized companies. All multi-cap funds have a certain portion of their portfolios in shares of mid-cap companies (and some of them in shares of small-sized ones as well), but whether the portfolio tilts more towards them or away, is the question. Of the 59 multi-cap funds, 39 schemes have at least 30% exposure in such stocks, according to Value Research. Four schemes have a majority of their respective portfolios in small- and mid-cap companies, with BOI Axa Equity Fund (BAEF) having 58% of its portfolio in mid- and small-cap scrips.
Although multi-cap schemes are supposed to diversify between large-cap and mid-cap (including small-cap) companies, sometimes the fund manager invests significantly in large companies. As a result, a multi-cap fund can also start getting classified as a large-cap fund. In March 2013, Reliance Vision Fund, an erstwhile large-cap fund got re-classified as a multi-cap fund. Six months later, it got re-classified as a mid-cap fund. In March 2014, it got re-classified as a multi-cap fund again. In September 2016, it became a large-cap fund, based on classification parameters of Value Research. The fund house did not deliberately change the classification, as it has been managed as a diversified equity fund for many years now. This problem will go away next year as all fund houses will now have to strictly follow the new norms of fund classification as per the capital market regulator.
Apart from the fund manager’s track record, check your risk profile before you pick a multi-cap fund. Between two funds, just because one multi-cap fund gives higher returns, doesn’t necessarily mean it is the better of the two. The higher returns may have also come because of an aggressive management, which may not hold in good stead always.