Flexi-cap fund or multi-cap fund? Which is a better investment option?

It's been almost a year since SEBI issued a circular changing the definition of multi-cap funds and adding flexi-cap funds into it. Continue reading to learn if flexi-cap or multi-cap makes more sense.

Following the mutual fund rationalization, the Securities and Exchange Board of India (SEBI) changed the definition of multi-cap funds, resulting in the introduction of the flexi-cap category. SEBI issued a circular on September 11, 2020, proposing that all multi-cap funds that wish to stay multi-cap funds should deploy at least 25 per cent of their assets each to large-cap, mid-cap, and small-cap funds by February 2021. This was done to ensure that the funds were what they claimed to be. With this, mutual fund investors were hesitant whether to continue investing in such funds, and stock investors were taken aback since such large selling and buying would produce a lot of volatility in the market.  

However, after a discussion and ideas from stakeholders, SEBI established a new category called flexi-cap. The definition was changed to allow multi-cap funds to distribute funds across market capitalizations. As a result, comparing these two makes perfect sense to determine which is superior. To reach this conclusion, we studied the Nifty 500 Total Returns Index (TRI), which represents flexi-cap funds, and the Nifty 500 Multi-Cap 50:25:25 TRI that represents multi-cap funds, where the study spans over 16 years, from January 2006 to December 2021.  

As we can see, Nifty 500 Multi-Cap 50:25:25 TRI in long-term does better than that of Nifty 500 TRI. This means that on returns front multi-cap funds do slightly better than flexi-cap funds. But risk is something that should not be ignored. 

When we put them through the volatility test, we can see that they are essentially identical in terms of risk, as assessed by standard deviation and downside deviation. The actual difference, however, can be seen in maximum drawdown. This metric demonstrates that the Nifty 500 Multi-Cap 50:25:25 TRI falls more than the Nifty 500 TRI. This indicates that, on average, multi-cap funds decline more than flexi-cap funds due to their asset allocation. 

As of December 2021, the category average allocation to multi-cap funds is 47 per cent, while the allocation to small-cap funds is 18 per cent. Likewise, the flexi-cap fund's allocation to large-cap and small-cap is 71 per cent and 7 per cent, respectively. Flexi-cap funds would fall less than multi-cap funds since they are large-cap skewed. As a result, flexi-cap funds are better suited to conservative investors, whilst multi-cap funds are more suited to moderate investors. Having said that, both travel along similar lines in terms of volatility.