Should you really invest in multi-cap funds?

The market regulator, SEBI has recently tweaked the structure of the multi-cap funds. Earlier, a multi-cap fund was allowed to invest across various market caps while having a minimum of 65 per cent of the total assets in equity and equity-related instruments. This means that they can invest not only in large-cap stocks but also, in mid-cap and small-cap stocks and that too in any proportion the fund manager may deem fit. Hence, if a fund manager believes that large-cap stocks are going to generate better returns, he can change the constituents of his portfolio accordingly. Nonetheless, it was observed that most of the time, the multi-cap funds invested a larger portion of the fund in large-cap stocks.

Hence, to make these funds ‘true to the label’, the regulator has come out with a circular that requires multi-cap funds to invest at least 25 per cent of portfolios in large, mid and small-caps stocks each. Existing schemes will have to comply with the circular within one month of AMFI publishing the new list of large, mid and small-cap stocks in January 2020.

Why do we believe this is good for investors?

Looking at the current asset allocation of multi-cap funds and even at their historical allocation, we see that the investors were losing largely due to the under-representation of small-cap and mid-cap stocks in multi-cap funds. It is a well-known fact that though small-cap and mid-cap stocks are more volatile compared to large-cap stocks yet they tend to generate better returns than the large-cap stocks.

When you invest in a multi-cap fund, the fund manager, who is an expert having a good amount of experience and knowledge about the markets, can take a call and act upon it without any delay. Nonetheless, we found that it was missing.

However, this again questions as to how multi-cap funds fare when it comes to the portfolio of large-cap, mid-cap, and small-cap funds. Is it worth getting your hands dirty and manage the portfolio yourself?

To understand it and get a better insight, we need to know how these categories (multi-cap, large-cap, mid-cap, and small-cap) have performed compared to each other during different timeframes. Besides, we have also taken the equity bellwether index, Sensex, to understand the return pattern of funds. While studying the performance, we have considered 1-year, 3-year, and 5-year annualised rolling returns for the period between June 11, 2009, and June 19, 2020. It is to be noted that the rolling returns have been calculated on the daily NAVs for the period and an average of the same is taken.

The following table shows the average returns generated by different categories of funds over different time periods.

*Equal weighted portfolio of large-cap, mid-cap, and small-cap funds

If we look at the above table, we can see that under different categories, mid-cap funds have consistently outperformed other fund categories in all the timeframes. It is followed by the small-cap funds and equal-weighted portfolio of large-cap, mid-cap, and small-cap funds. The frontline index Sensex, however, has performed poorly as compared to the other categories.

Therefore, we believe that the move will be good for investors who can digest volatility.