Looking for a go-anywhere fund? Opt for the new flexi-cap category

The requirement that debt funds must allocate 10 per cent of their portfolio to liquid assets will improve their risk profile

The Securities and Exchange Board of India (Sebi) has made a couple of changes through two circulars dated November 6. It has introduced a new equity fund category called flexi-cap. It has also made it mandatory for all categories of open-ended debt schemes barring a few — overnight, liquid, gilt, and gilt with constant duration — to hold a minimum 10 per cent of their net assets in liquid instruments.

New flexi-cap category

The flexi-cap category needs to fulfil only one regulatory requirement — a minimum of 65 per cent of its assets must be in equities. Most of the current multi-cap funds may find it difficult to stay in this category as taking a 25 per cent exposure to mid-caps and another 25 per cent to small-caps (as they are required to do by January 2021) will make them riskier. Most are likely to migrate to flexi-cap. “If your multi-cap fund moves to the flexi-cap category, stay put because its risk-return profile will remain unchanged and it is likely to be managed in the same manner as earlier,” says Vidya Bala, cofounder, Primeinvestor.in. If a new fund is launched in this category, avoid it. Bala suggests that investors should wait until it becomes clear whether the new fund will have a large-cap or a mid- and small-cap orientation.  

A flexi-cap fund can be part of your core portfolio. “The fund manager has the maximum flexibility here. If valuations of mid-caps and small-caps become expensive, he can shift to large-caps, and vice versa,” says Arun Kumar, head of research, Fundsindia.com. He adds that this category is well suited for people who do not want to take a view on market cap and want to leave this to the fund manager’s discretion.

The multi-cap category is for investors who believe that all three categories — large-, mid- and small-cap stocks — will perform over the long term. Before investing in one, however, make sure you have the risk appetite. “These funds are for aggressive investors only,” says Bala. Adds Kumar: “We have never seen funds operate with the kind of allocation prescribed for multi-cap funds, so it may be better to wait and see how they perform.” These funds could find themselves on a sticky wicket when mid- and small-cap valuations turn exorbitant.

10% allocation to liquid assets

Debt funds must now have at least 10 per cent exposure to liquid assets like cash, government securities, T-bills, and repo on government securities. A higher liquidity buffer will make these funds more resilient. “They will be better placed to deal with sudden changes in the market environment and handle redemption pressures,” says Mahendra Jajoo, head of fixed income, Mirae Asset Global Investments.

The fear that this step may dampen returns of debt funds are unfounded. “Most funds already hold a part of their portfolio in liquid instruments. The impact on returns may not be more than 5-10 basis points,” says Kumar. The move will provide an additional layer of safety. Bala warns that while the new provision will help funds deal with normal levels of redemption, it may not suffice in situations of extreme panic.