One flexi-cap, one mid-cap, one small-cap fund. Is your portfolio really diversified? Experts explain

Investors often assume that spreading their money across different mutual fund categories automatically creates a diversified portfolio. A combination of one flexi-cap, one mid-cap and one small-cap fund may appear to offer exposure across companies of different sizes. However, experts say the number and labels of funds are less important than what the schemes actually hold.

A flexi-cap fund itself can invest across large-, mid- and small-cap stocks. Therefore, adding separate mid-cap and small-cap funds may increase exposure to those segments without necessarily providing an equivalent increase in diversification.

“Three funds can be enough, but simply combining three categories does not guarantee diversification,” said Unmesh Kulkarni, Managing Director and Group Product Head. He said investors should look beyond fund labels and examine stock overlap, sector concentration, market-cap exposure and investment style.

For instance, two funds belonging to different categories could still own several of the same companies or have similar sector and factor exposures. In such a situation, an investor may own three schemes but remain exposed to similar risks.

Uttam Agarwal, Chief Business Officer at Bajaj Capital, also said three funds can provide a good starting framework, but the number of funds alone does not determine diversification.

“Two or three funds can still have significant overlap in stocks, sectors or investment themes, which may create an illusion of diversification,” Agarwal said.

More mutual funds do not always mean more diversification

Investors sometimes add schemes from different asset management companies believing that spreading investments across fund houses will reduce risk. Experts caution against using the number of AMCs or schemes as a proxy for diversification.

Kulkarni said investors should prioritise diversification of the underlying portfolio, followed by investment style and fund-management approach. Diversifying across fund houses can be useful, but it should not be considered diversification in itself.

“Three funds from three different AMCs does not necessarily reduce risk if all three have similar holdings,” he said. Conversely, two funds from the same AMC could provide meaningful diversification if their mandates, portfolios and investment styles are genuinely different.

Agarwal similarly recommended looking first at the underlying portfolio. Investors can then consider differences in investment styles and fund managers as additional layers of diversification.

The practical test is whether the funds provide different sources of risk and behave differently across market cycles, rather than simply carrying different names.

Investors should therefore check the top holdings, sector exposure, market-cap allocation and concentration of each fund before deciding whether another scheme is actually necessary.

How much should investors allocate to flexi-cap, mid-cap and small-cap funds?

There is no universal allocation that suits every investor. The appropriate mix depends on risk capacity, investment horizon and the amount of volatility an investor can tolerate.

For a long-term investor with a higher risk appetite and a 10-year or longer horizon, Kulkarni suggested a reasonable starting framework of around 50–60% in flexi-cap funds, 20–30% in mid-cap funds and 15–20% in small-cap funds.

A more conservative investor could keep a larger share in flexi-cap funds and limit exposure to mid- and small-cap funds.

The key is not to increase mid- and small-cap exposure simply because these segments may offer higher long-term return potential. They can also experience greater volatility, deeper drawdowns and, particularly in smaller companies, liquidity risks.

Agarwal said investors with longer horizons and a higher tolerance for volatility have greater room for mid- and small-cap exposure, while moderate-risk investors may be better served by keeping flexi-cap as the larger core allocation.

The allocation should therefore reflect how much volatility an investor can actually remain invested through rather than being driven purely by expected returns.

Recent investor flows also indicate continued appetite for these categories. Mid-cap funds received ₹6,989 crore of inflows in August 2026, while small-cap funds received ₹7,973 crore, according to data cited by Kulkarni.

Should first-time investors own all three categories?

Not necessarily. For investors entering equity mutual funds for the first time, experts say simplicity can be more useful than immediately building a multi-fund portfolio.

A single well-selected flexi-cap fund can provide exposure across market-cap segments and serve as the core of an equity portfolio. Investors who prefer a low-cost, rules-based approach could alternatively consider a broad-market index fund.

“As the investor gains experience, understands their risk tolerance and has a longer investment horizon, mid- and small-cap exposure can be added where appropriate,” Agarwal said.

Kulkarni also cautioned against assuming that a larger number of funds automatically means lower risk. Additional schemes should have a distinct role or provide a different source of exposure.

For a first-time investor, starting with one diversified core fund may also make it easier to understand how equity markets behave and whether they can remain invested during periods of sharp volatility.

Once an investor has developed a higher tolerance for market fluctuations and has a sufficiently long investment horizon, adding mid-cap or small-cap exposure can be considered.

Ultimately, the question is not whether an investor owns three, five or six mutual funds. It is whether the portfolio is diversified across different sources of risk. Three genuinely differentiated funds can be sufficient, while several overlapping schemes can leave an investor with a concentrated portfolio despite appearing diversified on paper.