Flexi-cap funds are back in favour. But do they really offer the best diversification?

The timing of this surge is telling. After a prolonged rally in mid- and small-cap stocks, valuation comfort has begun to shift back towards large-caps. As a result, flexi-cap funds, by virtue of their tilt towards large-cap stocks, have started to outperform others.

This has reinforced a popular belief among investors: flexi-cap funds offer diversification without forcing exposure to expensive segments of the market. But flexi-caps are not the only category that promises diversification across market caps. Multi-cap funds, too, invest across large-, mid- and small-caps, but with some fixed allocation mandate.

That raises a key question: are flexi-cap funds truly the best option, or do multi-cap funds offer a better diversification framework over time?

Why are flexi-cap funds drawing money now?

The renewed interest in flexi-cap funds coincides with a visible shift in market leadership. Over the past year, large-caps have begun to regain relative strength as valuations in mid-cap and small-cap stocks have stretched.

“Going by the key market cap indices to total market ratio, large caps are currently trading at reasonable levels," said Sriram BKR, senior investment strategist, Geojit Investments.

Large-caps, he noted, are available at a 6-7% discount to their 10-year average valuations. In contrast, small-caps trade at a 12% premium, mid-caps at a 20.7% premium, and micro-caps at a steep 38% premium.

Basically, after several years where small- and mid-caps stole the spotlight with outsized returns, large-caps now look relatively undervalued.

This valuation divergence has made investors cautious about indiscriminate exposure to the broader market with experts asking investors to consider rebalancing towards large caps as they are likely to offer better risk-adjusted returns in the current market setup.

Flexi-cap funds are structurally well-placed to respond to this environment. Unlike multi-cap funds, they are not bound by minimum allocation requirements across market-cap segments, allowing fund managers to adjust exposure as needed, depending on their valuation comfort.

Multi-cap funds must invest at least 25% each in large-, mid- and small-cap stocks, with only the remaining 25% left to discretion. Flexi-cap funds, in contrast, operate under just one condition–a minimum 65% allocation to equities, allowing managers far greater room to respond to changing market conditions.

Flexi-caps and their large-cap bias

Portfolio data shows that flexi-cap funds have, in practice, been consistently tilted towards large-cap stocks.

Between January 2021 and November 2025, flexi-cap funds held more than 60% of their portfolios in large caps in 32 out of 59 months. On average, large-cap allocation stood at 61.36% during this period.

The range of exposure has been wide. At the higher end, monthly large-cap allocation moved between 72.13% and 90%, indicating that portfolios have remained structurally skewed towards large caps.

This is not accidental, say experts.

“Large-caps help reduce portfolio volatility. Flexi-cap funds are ideal for core portfolios, with allocation flexibility as their key edge," said Anup Bhaiya, founder, Money Honey Financial Service, an Amfi-registered mutual fund distributor.

Benchmarking also plays a role. Rajat Chandak, senior fund manager, ICICI Prudential Mutual Fund, pointed out that most flexi-cap schemes benchmark themselves to broad market indices such as BSE 500, where large-caps account for over 70% of the weight. “Viewed against this benchmark, many flexi-cap portfolios could actually be underweight large caps and relatively overweight mid- and small-caps," he said.

Scale further constrains aggressive positioning. According to Vinayak Magotra, product head & founding team, Centricity WealthTech, a digital wealth management platform, flexi-cap funds are among the largest schemes in the industry.

“Parag Parikh Flexi Cap Fund manages around ₹1.29 lakh crore, HDFC Flexi Cap manages about ₹94,000 crore," he noted. At that size, excessive exposure to smaller stocks can increase liquidity concerns.

Where do multi-cap funds differ?

Multi-cap funds operate under a very different framework. The mandatory minimum allocation of 25% each in large-, mid- and small-caps, was to enforce genuine diversification. It aimed to prevent funds from masquerading as multi-cap while behaving like large-cap schemes.

Over the past few years, that discipline has delivered results.

Annual category average returns data show that multi-cap funds have outperformed flexi-cap funds in every calendar year from 2021 to 2024. It was only in 2025 that flexi-cap funds began to pull ahead, aided by their heavier exposure to large-cap stocks.

As per Magotra, “Over time, the combined 50% exposure to mid and small caps has helped multi caps generate higher returns during broad-based rallies."

However, that same discipline can become a constraint when valuations become stretched or leadership becomes overly narrow. “It can limit a multi-cap fund manager’s portfolio construction flexibility," said Jiral Mehta, senior manager – research, FundsIndia, an online investment platform.

Performance during market stress

The difference between flexibility and discipline becomes most evident during market corrections.

Since January 2021, the Nifty 500 index has witnessed two sharp drawdowns of over 15%. During these periods, flexi-cap funds demonstrated better consistency in limiting losses.

Across the two drawdowns, on average, flexi-cap funds fell less than the Nifty 500 in two instances, while multi-cap funds managed this feat only once. The worst-case drawdowns in multi-caps were often deeper than those of flexi-caps.

According to Chandak, flexi-cap funds have generally demonstrated better downside management due to their ability to tilt portfolios towards higher-quality large caps or defensives when risk rises.

“Multi-cap funds, by design, cannot reduce exposure to more volatile segments below mandated levels," he added, which can amplify short-term drawdowns even if long-term outcomes remain reasonable.

Not a verdict yet

Despite the recent divergence in performance and flows, experts caution against drawing firm conclusions.

Since Sebi’s reclassification, the two categories do not yet have a long enough common track record to make definitive judgments across full market cycles. Annual returns offer insights, but longer-term behaviour, especially across multiple valuation regimes and market cycles, still needs to be observed.

“Over the long term, returns tend to converge," says Bhaiya of Money Honey Financial Service. “Both categories are likely to deliver similar performance, though theoretically multi-cap funds can generate around 1-2% higher returns than flexicap strategies."

Magotra of Centricity WealthTech also stresses that comparisons based purely on recent returns can be misleading.

As per Chandak, “flexi-cap is a strategy-driven product, while multi cap is an allocation-driven product," he says. Each is designed to solve a different investor need.

Who should choose what?

Both these categories are designed to serve different investor objectives and expected returns.

Flexi-cap funds, as per Magotra, are aimed at investors seeking relatively stable portfolios with lower volatility, while multi-cap funds are oriented toward generating higher long-term returns, but with higher volatility.

Therefore, category selection should begin with clearly defining the investment objective.

And the real test ultimately for both will play out over time, as cycles turn and valuations reset.