Confused between flexicap and multicap? Here’s how to choose

The Amfi data on mutual fund flows for January saw the debut of a new equity fund category—flexicap funds. This category was notified by Sebi in November 2020 after a change in the definition of multicap funds gave rise to the need for a category that followed a more flexible investment mandate in line with the strategy followed by multicap funds before the change in rules.

With the new rules kicking in as of 1 February, fund houses could choose to re-categorize erstwhile multicap schemes as flexicap schemes if they wanted to continue with the earlier style.

A majority of the schemes have chosen to move to the new flexicap category and fund houses such as Axis and Kotak have filed draft prospectus to launch schemes under the multicap category.

How should investors approach this transition and choose between the two categories?

Flexicap and multicap funds will have portfolios that are constructed to different mandates, and investors should have different risk and return expectations from them.

Multicap funds will now invest at least 25% each in large, mid and small cap segments. While fund managers still have 25% elbow room to give the portfolio an edge by hiking exposure to the segment they believe will do well, it takes away their ability to reduce exposure to a segment expected to do poorly, thus making the fund riskier.

“Given the illiquidity in the small cap segment of the market, a 25% allocation in the small cap segment, with the option to go up as high as 50%, may be too risky for most investors,” said Melvin Joseph, a Sebi-registered investment adviser and founder of Finvin Financial Planners.

The flexicap category of equity funds, on the other hand, will invest at least 65% of the total assets in equity investments without any defined limits in terms of exposure they should take to large, mid or small cap segments of the market.

The experience of investors in multicap funds in their earlier flexible avatar was that many of these schemes chose to be large-cap heavy. This means they may underperform when the mid and small cap segments of the markets take a lead. There is also the risk of the fund manager going wrong in their reading of the risk and return profile of the different market segments.

If you have the erstwhile multicap fund in your portfolio, then check which of the two categories the fund has chosen. The decision of the fund to switch to the flexicap category will mean that the fund intends to continue with its existing flexible portfolio strategy.

If the fund chooses the new multicap regime, it would mean a change in risk and return assessment of the fund since the portfolio will now have to align to the revised rules. Also, check if there are other changes in the investment management strategy.

For example, Aditya Birla Sunlife Equity Fund, an erstwhile multicap fund, has chosen to move to the flexicap category and has also altered its investment mandate to add international equity to its investment universe.

In this case, investors need to assess their comfort with global stocks in their portfolio.

Understand the portfolio strategy

For investors with limited investible surplus, a flexicap or multicap will work as a good first investment that gives them exposure to different segments of the stock market. They now have the option to choose between the flexible portfolio strategy of flexicap funds and the fixed allocation strategy of multicap funds. Use this opportunity to understand the investment strategy before making an investment decision.

If it’s a flexicap fund, understand how the fund interprets this flexibility. Does it intend to dynamically alter the portfolio’s exposure to the different segments of the market according to expected performance? Or does it intend to seek suitable investment opportunities irrespective of whether it is in the large, mid or small cap space? Or if the fund intends to have a preference for a certain segment, say large caps, with some exposure to the other segments depending upon the market valuations?

If investors are not comfortable with the fund manager having the flexibility to decide on segment exposure and would like a more structured portfolio with greater visibility, then the multicap category is what they should consider.

However, the rigidity of the exposure that the category has to take may make the fund riskier.

What should investors do?

Consider a change in the category of equity fund if the needs of your goals from your investments have changed.

“If a change is called for, first make it in the new money that the investor is bringing in. For the existing investment, consider the impact of exit loads and taxes and execute it as part of the periodic rebalancing exercise in the investor’s portfolio,” says Renu Maheshwari, a Sebi-registered investment adviser, CEO and principal adviser, Finscholarz Wealth Managers LLP.

looking for A longer investment horizon?

A change of category will mean that you have to realign to the risk and return parameters of the new category. If you are considering a switch to a multicap fund, you may require a longer investment horizon as compared to a flexicap fund given the larger exposure to mid and small cap segments of the market. Investors looking to benefit from the long-term growth prospects of mid- and small-sized companies may find this a good way to participate. Or, it may be used to capitalize on an upturn in the mid and small cap segments with the allocation to large caps acting as a safety buffer.

“An SIP in a small cap fund may be a better way to take exposure to this segment in line with the investor’s risk profile rather than as a part of a larger ticket multicap investment where the exposure may go as high as 50%,” said Joseph.

A large-cap oriented flexicap fund may be suitable for investors looking for a stable ride with mid and small caps giving a boost to returns. On the other hand, flexicap funds that look at actively managing segment allocations in line with expected performance may be suitable for those investors who are willing to take greater risks for better returns.