Flexicap funds offer managers total freedom, while multicap funds must follow a strict SEBI rule of 25% allocation to large, mid, and small-cap stocks. While multicap schemes have delivered higher returns in recent years, they come with higher volatility. Investors can use these categories as complementary parts of a portfolio rather than choosing one over the other.
What Happened
Investors often face a choice between Flexicap and Multicap mutual funds. The primary difference between these two categories lies in how they manage money. Flexicap funds give the fund manager complete freedom to decide how much to invest in large, mid, or small-cap stocks. In contrast, Multicap funds follow a strict rulebook set by the Securities and Exchange Board of India (SEBI). This rule requires them to invest at least 25% of their total assets in large-cap stocks, 25% in mid-cap stocks, and 25% in small-cap stocks. This structural difference significantly changes how these funds perform depending on market conditions.
The 25% Rule And Its Impact
The SEBI mandate for Multicap funds is designed to ensure true diversification across market sizes. Because these funds must keep 25% of their money in mid-cap and another 25% in small-cap stocks, they are naturally more sensitive to market rallies in these segments. When the market sees a broad rally, particularly in smaller companies, these funds often deliver higher returns. However, this same rule acts as a double-edged sword. If the small and mid-cap segments face a downturn, the fund cannot simply exit these positions to protect capital, as it must maintain the 25% allocation. This constraint makes them more volatile than their Flexicap counterparts.
The Flexicap Flexibility Advantage
Flexicap fund managers have the authority to move money across market capitalizations based on their outlook. In practice, many Flexicap funds lean heavily toward large-cap stocks, which are generally more stable. By keeping a higher weightage in established large companies, these funds often provide a smoother experience during market corrections. While they may miss out on some of the explosive gains seen during small-cap rallies, they often offer more consistency for investors who prefer a defensive approach.
Why Performance Diverges
Recent data shows that Multicap funds have outperformed over three- and five-year periods. This performance gap is usually linked to the specific market cycles that favored mid and small-cap stocks. Because Multicap funds are forced to hold these stocks, they benefit more during these phases. Flexicap funds, which may have chosen to reduce exposure to smaller companies for safety, might show lower returns in such environments. Investors must recognize that this is not necessarily a failure of the Flexicap strategy, but rather a reflection of the different mandates.
The Risk Of Changing Funds
It is common for investors to switch funds when they see a category performing better. However, moving money solely because a Multicap fund is currently beating a Flexicap fund can be risky. Market leadership changes over time; a sector that is leading today may lag tomorrow. Instead of switching, investors often view these funds as complementary tools. A Flexicap fund can act as the stable, large-cap-heavy core of a portfolio, while a Multicap fund can be added to capture growth from smaller companies.
What Investors Should Track
When evaluating these funds, check the fund manager’s long-term track record rather than just the last year's returns. For Multicap funds, look at how the fund managed the mandatory 25% allocation during past market crashes to understand its risk management style. For Flexicap funds, monitor the asset allocation trends in their monthly fact sheets to see how much exposure they currently have to large versus small companies, as this indicates their current view on the market.