Flexicap funds explained: Do they provide the play your mutual funds portfolio needs?

• Flexi cap funds can invest across different market capitalisations such as large, mid and small caps.
  
• Their appeal lies in the hands-on management provided by a professional, alleviating the need for investors to engage in extensive deliberation.
  
• Investors are advised a long term horizon, at least five years or more, while investing in flexi cap funds.
  

As of November 30, 2023, the assets under management in the flexi-cap category totaled ₹3.06 lakh crore, making it the largest asset base within the equity category, according to Association of Mutual Funds in India (AMFI) data.

Market regulator, SEBI had introduced new guidelines for multi-cap funds on September 11, 2020. The main essence of these proposed changes to the multi-cap category was that, starting from January 31, 2021, these funds would be required to allocate a minimum of 25% of their portfolio to large-cap, mid-cap, and small-cap stocks each.

After the announcement of the new guidelines regarding multi-cap funds, there were numerous discussions about the potential drawbacks for both investors and the markets. Recognising these concerns, SEBI appeared to acknowledge the issues and subsequently introduced a new category - flexi cap funds in November 2020.

Flexi cap funds can invest across different market capitalisations such as large, mid and small caps. The benefit of this strategy is that these funds can tweak the allocation across market cap as per the evolving opportunities.

For instance, if the fund manager foresees an impending economic downturn, he or she can tweak the portfolio towards large caps which can give relative stability and protect the downside to some extent. Similarly, having exposure to mid and small cap companies when there is a turnaround helps generate some extra alpha.

This flexibility allows fund managers to adjust their portfolio allocations dynamically, taking advantage of changing market dynamics and identifying potential investment opportunities across different segments of the market.

“It provides them with the freedom to invest in large-cap stocks when they see valuation comfort in that segment, and similarly, in mid-cap or small-cap stocks when they expect that market cap to do well,” says Amey Sathe, Fund Manager, Tata Mutual Fund.

Why the flexicap fund category is so big

The popularity of flexi cap funds stems from their inherent flexibility, sparing investors the need to navigate the complexities of choosing between mid-cap, small-cap, or large-cap investments.

“By opting for a flexicap fund, investors can simply allocate their funds to this class, entrusting the fund manager with the responsibility of strategic allocation based on market conditions,” says Soumya Sarkar, Co-Founder, Wealth Redefine, a mutual fund distribution firm.

The appeal lies in the hands-on management provided by a professional, alleviating the need for investors to engage in extensive deliberation over whether to focus on large-cap, mid-cap, or small-cap investments – a key reason why flexi cap funds are favoured by investors.

Most of the fund managers have been managing this category conservatively with a tilt towards large cap and use mid and small cap portions as a tool to alpha generation.

“Given the current scenario where large-cap has not run up much and small-cap has given a tremendous run, investors are allocating into the funds that are heavy on large-cap but at the same time give some flavour of mid and small-cap stocks which is talk of the town,” says Mukesh kochar National Head of Wealth at AUM Capital, a wealth management firm.

Returns

In the last one year, flexi cap funds as a category have given returns of 28.29% according to Valueresearch, while the three-year return has been 19.65%. Flexicap funds are benchmarked against the Nifty 500 Total Return Index (TRI) which has returned 22.51% in the last year.

“We expect the category to gain prominence in 2024 considering valuation in various market caps is at crossroads and there is no compulsion to invest in categories wherein valuations are expensive,” says Sathe.

Should you invest?

Choosing to invest in a flexi-cap fund demands careful thought owing to its high risk nature. Unlike more conservative alternatives like balanced advantage funds, hybrid funds, or large-cap funds, flexi-cap funds carry increased risk by distributing funds across mid-cap and small-cap categories.

This renders them inappropriate for risk-averse investors but appealing to those comfortable with higher levels of risk.

Investors must recognize that their money, regardless of the amount, will be invested in mid-cap and small-cap categories, requiring a sufficient risk appetite and time horizon.

“If investors lack these attributes, it may be advisable to avoid flexi-cap funds; however, for those willing to embrace some risk without extensive analysis, flexi-cap funds present a viable investment option,” says Sarkar.

Investors should thus have a long term horizon, at least five years or more, while investing in flexi cap funds. Investors should spread their allocation across funds with different styles (growth and value) for diversification.

Kochar advises that for the first-time investor, it is advisable to go through the balance advantage fund route as these are more stable and less volatile compared to a flexicap fund which is 100% equity-oriented.

These funds are relatively less risky as compared to sector or thematic funds. However, they are not completely immune to volatility. Thus, investors should be prepared to withstand some volatility and have a long term horizon while investing in this category of funds.