Your Questions Answered: I want to diversify my portfolio. Please elaborate on flexi-cap mutual funds

Flexi-cap mutual funds allow investments across large, mid, and small-cap stocks without restrictions, offering flexibility to adapt to market conditions. In contrast, multi-cap funds have specific allocation mandates.

Kuvera
Published22 Oct 2024, 03:03 PM IST
Flexi-cap mutual funds allow dynamic investment across large, mid, and small-cap stocks, providing a unique opportunity for diversification.
Flexi-cap mutual funds allow dynamic investment across large, mid, and small-cap stocks, providing a unique opportunity for diversification.

Q. I am a government employee working with the Karnataka State Government in Mysore. My wife is a dentist, running her own clinic in Mysore. We have been investing in large-cap mutual funds for the past 8 years. However, we want to now diversify and invest in flexi-cap mutual funds. However, we are confused about the difference between flexi-cap and multicap mutual funds. Can you please elaborate on the difference between the two and additionally on the pros and cons of investing in flexi-cap mutual funds?

K Sudarsha, Mysore, Karnataka

Equity mutual funds can be further divided into 15 sub-categories. Each has its own unique purpose and features. Within these categories, the flexi-cap category stands out, offering the flexibility to invest across companies of various market capitalisations. This adaptability makes them an attractive choice for investors looking to diversify their portfolios while tapping into the growth potential of different market segments.

Different market capitalisations

Before we jump into understanding what flexi-cap mutual funds are, it is important that we understand what are the different classifications of companies based on their market capitalisation.

The SEBI has classified these companies into three distinct segments: large-cap, mid-cap, and small-cap. This classification is pivotal for investors, mutual funds, and the overall market as it influences investment strategies and risk assessment.

  • Large-cap: These companies are the titans of the industry, often well-established and with a significant presence in the market. According to SEBI's guidelines, these are the top 100 companies in terms of full market capitalisation. Market capitalisation is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share. Large-cap companies are known for their stability and strong governance, and are usually industry leaders. They are considered to be less volatile compared to their mid-cap and small-cap counterparts and are often the preferred choice for conservative investors.
  • Mid-cap: These companies fall in the middle of the spectrum, ranked from the 101st to the 250th company based on full market capitalisation. These companies are typically in the growth phase of their business cycle and offer a balance between the stability of large-cap and the growth potential of small-caps. Mid-cap companies can provide investors with higher growth potential but come with a higher risk and volatility than large-cap companies.
  • Small-cap: Small-cap companies are the ones ranked below 251 in terms of full market capitalisation. These companies are often characterised by their high growth potential. However, they also come with a higher risk due to their lower market presence, lesser stability, and susceptibility to market fluctuations. Small-cap companies can be the stars of tomorrow, but they require investors to have a higher risk tolerance.

SEBI's classification helps in creating a structured approach to investing. It aids investors in identifying companies based on their market cap and aligning them with their investment goals and risk appetite.

Mutual funds also use this classification to create diversified portfolios that cater to different investor segments. For instance, large-cap funds invest primarily in the stocks of large-cap companies, providing stability and steady returns, while mid-cap and small-cap funds aim for higher growth, albeit with a higher risk. 

The classification also ensures uniformity in the categorisation of companies, which is essential for benchmarking and comparison. It provides a clear framework for the mutual fund industry to structure their schemes and for investors to understand where their money is being invested.

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Understanding flexi-cap mutual funds

Flexi-cap mutual funds are open-ended dynamic equity schemes that invest across large-cap, mid-cap, and small-cap stocks. The defining characteristic of these funds is the absence of any SEBI imposed restrictions on the allocation across market caps, allowing fund managers to tailor the portfolio in response to changing market conditions and opportunities.

SEBI regulations on flexi-cap mutual funds

SEBI introduced the flexi-cap category in November 2020, with the aim of providing a clear and distinct identity to funds that have the leeway to invest across market caps without any prescribed limits. As per SEBI's mandate, flexi-cap funds must invest a minimum of 65% of their total assets in equity and equity-related instruments.

Investment limits in different market caps

Unlike other fund categories such as large-cap mutual funds that have specific allocation mandates for different market caps, flexi-cap funds are not bound by such constraints. This means that fund managers have the discretion to invest in large-cap, mid-cap, or small-cap stocks based on their investment strategy and market outlook. 

For instance, while large-cap are mandated under SEBI regulation to invest 80% of their corpus in large-cap companies, flexi-cap funds do not face such limitations.

The flexibility advantage

The inherent flexibility of flexi-cap funds allows for strategic shifts between market caps, enabling fund managers to capitalise on market rallies or protect the portfolio during downturns. This flexibility can potentially lead to better risk-adjusted returns over the long term.

Difference between flexi-cap and multi-cap mutual funds

In the diverse world of mutual funds, investors are often presented with a plethora of options, each tailored to different market conditions and investment goals. Among these, flexi-cap and multi-cap mutual funds stand out as popular choices for those looking to diversify their portfolios across various market capitalisations.

However, understanding the nuances between these two fund categories is crucial for making informed investment decisions. We have discussed flexi-cap mutual funds and their investment approach above.

On the other hand, multicap mutual funds operate under a specific mandate set by SEBI. These funds are required to maintain a minimum investment of 25% in each category of large-cap, mid-cap, and small-cap stocks. This regulation ensures a balanced exposure to different market segments, potentially reducing risk through diversification while still allowing for growth opportunities.

Key differences

Allocation and volatility: The primary distinction between flexi-cap and multi-cap funds lies in their allocation strategy. While multicap funds are bound by the SEBI mandate to invest a minimum of 25% in each market cap category, flexi-cap funds are at the discretion of the fund manager, who can adjust allocations based on market conditions and investment outlook. 

This difference in allocation also influences the volatility and risk profile of the funds. Multicap funds, due to their mandatory investment in mid and small-cap stocks, may exhibit higher volatility and aggressive growth potential. 

Flexi-cap funds, with their adaptable approach, can potentially offer a more balanced risk-reward ratio, as the fund manager can shift focus to more stable large-cap stocks during market downturns or explore growth in small caps when favourable.

Goals and risk appetite: Investors should consider their financial goals and risk appetite when choosing between flexi-cap and multi-cap funds. Those with higher risk tolerance and a focus on aggressive growth may find multi-cap funds appealing due to their exposure to mid and small-cap stocks. Conversely, investors seeking a more controlled approach that adapts to market changes might prefer the strategic flexibility offered by flexi-cap funds.

Both flexi-cap and multi-cap mutual funds offer unique advantages and cater to different investment strategies. By understanding the key differences in allocation requirements and volatility, investors can make choices that align with their individual financial objectives and market outlook.

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Pros and cons of flexi-cap mutual funds

Flexi-cap mutual funds have garnered attention for their unique ability to adapt to market conditions by allocating assets across various market capitalisations without restriction. This flexibility is a significant advantage for investors looking for a diversified portfolio with the potential for substantial returns.

  • Diversification: One of the primary benefits of investing in flexi-cap funds is the inherent diversification they offer. By spreading investments across various market caps, these funds can potentially reduce the risk associated with market volatility. Diversification is a cornerstone of sound investment strategy, and flexi-cap funds naturally embody this principle.
  • Flexibility: The ability to shift asset allocation between market caps allows fund managers to capitalise on market opportunities. For instance, during a market rally, the fund can increase its exposure to mid and small-cap stocks to maximise growth. Conversely, in a downturn, the fund can seek refuge in the stability of large-cap stocks.
  • Professional management: Flexi-cap funds are managed by experienced fund managers who make informed decisions based on extensive research and market analysis. Investors benefit from the expertise of these professionals who can navigate the complexities of the market and adjust the portfolio to optimise returns.
  • Potential for higher returns: With the freedom to invest across market caps, flexi-cap funds are well-positioned to pursue higher returns. The fund managers can identify and invest in high-growth opportunities irrespective of the company's size, which can lead to better performance compared to more restricted fund types.
  • Adaptability to market changes: The market is ever-evolving, and flexi-cap funds are designed to adapt to these changes. Whether it's a shift in economic policies, market trends, or sector performances, flexi-cap funds can adjust their holdings to align with the current market environment.
  • Suitable for various investment horizons: Whether you're investing for the short term or the long term, flexi-cap funds can be an appropriate choice. Their dynamic nature allows them to be tailored to different investment horizons, making them a flexible option for a wide range of investors.

Investing in flexi-cap mutual funds can be a strategic move for those seeking a balanced and adaptable investment vehicle. With their unique advantages, these funds continue to be a popular choice among discerning investors looking to optimise their portfolios for growth and stability.

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Cons of investing in flexi-cap mutual funds

  • Market performance sensitivity: Flexi-cap funds may underperform in certain market conditions. For instance, if a fund is heavily weighted towards large-cap stocks during a period when small and mid-cap stocks outperform, investors may see diminished returns. Conversely, a tilt towards smaller caps in a bear market could lead to significant losses.
  • Requires active monitoring: Investors in flexi-cap funds need to be vigilant and actively monitor their investments. The funds' allocations can shift significantly over time, necessitating periodic reviews to ensure alignment with one's investment goals and risk tolerance.

Taxation

The Union Budget 2024 has introduced significant changes to the taxation of mutual funds, particularly affecting flexi-cap mutual funds. This blog post delves into the details of the new tax rules and offers insights into how they may impact your investments in flexi-cap mutual funds.

Taxation changes post Budget 2024

The Budget 2024 has overhauled the capital gains tax structure for mutual funds. Here's a summary of the key changes:

  • Rationalisation of holding periods: The holding periods for short-term and long-term capital gains have been standardised to 12 and 24 months, respectively.
  • Uniform long-term capital gains tax (LTCG): The indexation benefit on long-term capital gains has been removed, leading to a uniform tax rate of 12.5% for all asset classes.
  • Increased short-term capital gains tax (STCG): Short-term capital gains tax on equities and equity-oriented funds has been increased to 20%.

Impact on flexi-cap mutual funds

The increase in STCG tax from 15% to 20% will affect those who prefer to trade frequently or redeem their investments within a short period. This change emphasises the government's focus on encouraging long-term investments over short-term trading.

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Strategic adjustments for investors

Investors may need to reconsider their investment strategies in light of these changes. Here are some strategies to consider:

  • Long-term focus: With the increased STCG tax, it may be more beneficial to hold investments for longer than 12 months to avail of the lower LTCG tax rate.
  • Tax planning: Effective tax planning will become crucial. Investors should consult with tax advisors to understand the impact of these changes on their overall tax liability.

Conclusion

Flexi-cap mutual funds offer a unique blend of flexibility and diversification, making them a compelling option for investors seeking exposure to equities across market caps. With the ability to adapt to market changes and the freedom to invest without cap-specific constraints, flexi-cap funds can be a valuable addition to an investor's portfolio.

For those interested in exploring this investment avenue, it's crucial to stay informed about the latest SEBI regulations and market trends to make well-informed decisions. As always, consulting with a financial advisor can provide personalised guidance tailored to individual financial objectives and risk tolerance.

Kuvera is a free direct mutual fund investing platform. Unless otherwise stated data sourced from BSE, NSE and kuvera.

 

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First Published:22 Oct 2024, 03:03 PM IST
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