Benefit from multi-cap funds

In a year when bottom-up stock picking is likely to be the key to success, investors should consider them

Experts are predicting that 2016 will be a year when bottom-up stock picking will trump top-down and sector-based investing. In such an environment, multi-cap funds, which enjoy a lot of leeway in terms of where the fund manager can invest his corpus, are a good bet for retail investors.

Multi-cap advantage

Multi-cap funds can shift their portfolios across market caps. They can hold large-cap or mid-cap stocks, or a mix of both. More importantly, they can take exposure to any type of stocks at the opportune moment. "When valuations of large-cap stocks are more attractive, as was the case in 2015 after the initial correction, multi-cap funds took exposure there. In 2013 there was an opportunity to invest in quality midcaps at reasonable valuations. The ability to move across market caps at the opportune moment gives these funds an edge," says Vidya Bala, head of research, Fundsindia.com. For the retail investor, this means that he doesn't have to worry about which market cap to invest in. Says Gautam Sinha Roy, Fund Manager, MOSt Focused Multicap 35 Fund: "By investing in a multi-cap fund, the retail investor can leverage a fund manager's expertise in terms of taking market cap and sector related calls."

 

 

In contrast, large-cap funds are restricted by their mandate. They can't take more than a 10-15 per cent exposure in midcaps in a rising market, when mid-caps typically tend to outperform large-cap. Similarly, a mid-cap fund can't seek refuge in the more stable large-cap stocks in a falling market to restrict the erosion in the value of its portfolio (mid-cap stocks usually fall harder than large-caps in a bearish market). All that a mid-cap fund manager can do is move a part of his portfolio into cash.

But a multi-cap fund can change its nature according to the situation. It can enjoy the stability that exposure to large-cap stocks provides, and at the same time take exposure to mid-cap stocks to prop up its return. So, a good multi-cap fund can provide sound risk-adjusted returns over the long term (see table). Essentially, these provide investors best of both - large- and mid-cap funds.

Risks

Sometimes, if the move that multi-cap funds make is extreme, that is, they move into large-cap stocks or into mid-cap stocks in a big way, and the call goes wrong, these funds can suffer massively. Constant shifting of the portfolio can also lead to higher volatility, causing these funds to have a higher standard deviation, which is a parameter to gauge a fund's risk. Larger standard deviations indicate larger degrees of risk.

"When you invest in a pure large-cap fund or a pure mid-cap fund, you know what you are getting into. But since multi-cap funds' mandate allow them to change their nature, they come with higher uncertainty," says Bala.

Before you invest…

Investors need to scrutinise the track record of the fund manager carefully before investing in a multi-cap fund. How has he fared in terms of identifying the right market cap, sector and stocks in the past? The investor also needs to check how the fund has performed in different (bull and bear) phases of the market. "The breadth of choices that the manager of a multi-cap fund enjoys is much greater. But the fund manager must also have the requisite broad understanding of sectors and companies to be able to take advantage of his mandate. Hence, be focused doubly on fund manager competence when investing in a multi-cap fund," says Sinha Roy.

Before investing in a multi-cap fund, an investor should check whether it fits into his risk profile, investment horizon and goals. A conservative investor, who wants very little volatility in his portfolio, may prefer to stick to large-cap funds only.

A multi-cap fund will give you a good dose of exposure to mid-cap stocks. This could be as high as 30-40 per cent of the fund's portfolio. An investor needs to construct his overall portfolio keeping this fact in mind. Having taken exposure to multi-cap funds, he should not then take excessive exposure to pure mid-cap funds also, or else his exposure to the more volatile mid-cap stocks could exceed his risk appetite.

An investor shouldn't draw conclusions about the nature of a multi-cap fund based on an examination of its portfolio over just one quarter. He should observe it over several quarters, or take the help of an expert. At one point, a multi-cap fund may be predominantly exposed to large-caps. An investor shouldn't invest in it thinking it is large-cap in nature or else he will get an unpleasant surprise when in a few quarters the fund morphs into a mid-cap fund. A look at the objectives of the scheme in the scheme information document will help in this regard.

Finally, multi-cap funds are not a homogenous lot in terms of risk. Within the category, some funds take a lower degree of risk (as they have a lower limit on exposure to mid-cap stocks) while others court higher risk in the quest for higher returns. Funds like Franklin India Prima Plus, BNP Paribas Equity, and Mirae India Opportunity primarily have a large-cap focus but can take some exposure to midcaps also. Others like Franklin India High Growth Companies and Reliance Equity Opportunities can move towards midcaps in a big way.

Exposure

When constructing a portfolio catering to a long-term goal, take into account your risk appetite. First buy large-cap funds and then add multi-cap funds. For conservative investors, a portfolio comprised entirely of large-cap and multi-cap funds without any exposure to mid-cap funds will suffice. More enterprising investors may have a 30-40 per cent exposure to large-cap funds, another 30-40 per cent to multi-cap funds, 10-15 per cent to international funds, while mid- and small-cap funds can take up the rest.