When you buy equity mutual funds, you normally have a choice between large cap, mid cap and small cap funds. As an investor it can become quite difficult to choose funds within each category based on a variety of parameters. One of the ways to overcome this problem could be Multi-Cap Funds. These multi-cap funds create a hybrid portfolio consisting of large cap, mid cap and small cap stocks. In fact, such funds begin with an allocation towards each category and then go about stock picking within each category. To understand this issue let us look at the live date of various categories of indices..
Date Source: NSE
In the above chart we have plotted the Nifty, Mid Cap index and the small cap index. To make them comparable we have indexed these 3 index charts to the base of 100 over the last 1 year. Over the last 1 year, the Nifty has returned 13.18% while the Mid-cap index has returned 17.65% while the small cap index has returned 16.71%. In fact, if you go back to the last 3-4 years you will find that there is a greater outperformance by the mid cap and small cap funds compared to the Nifty. That surely makes a case for inclusion of mid cap and small cap as part of your fund strategy.
You have 2 choices in front of you..
You can either opt to allocate funds to large caps funds, mid caps funds and small cap funds and manage these funds separately
Alternatively, you can invest in multi-cap funds wherein the fund manager automatically creates a portfolio of large cap, mid cap and small cap stocks.
Which of these choices should you prefer?
It is quite clear that there is merit in creating a hybrid portfolio of large caps, mid caps and small caps. Over the longer period, the alpha generated by such a portfolio is higher. The question is the methodology. Should you opt for creating your own mix of large cap, mid cap and small cap funds or should you opt for a multi-cap fund? There are 4 factors to consider here..
1. Simplicity of management: In terms of simplicity, the multi cap fund definitely makes the job easier for you. You need not worry about identifying the large cap funds, mid cap funds and small cap funds and deciding on the allocations. The multi-cap fund manager does the allocation and creates a multi-cap portfolio on your behalf.
2. Benefit of diversification: In terms of diversification, both these approaches work well enough. Whether you choose a multi-cap fund or whether you opt for allocating yourself, the benefit of diversification across capitalization is available to you in both the cases. Of course, if you opt for doing it on your own then you can do the allocation of your choice in consultation with your financial advisor. The multi-cap fund will give it to you as a package.
3. Measuring in terms of flexibility: Allocating funds on your own to mid cap and large cap funds offers you more flexibility to customize it according to your financial plan. The multi-cap fund managers will adopt one median approach to investing in multi-cap stocks whereas you can customise to your unique requirements. For example, if you are 45 and do not have an appetite for small cap stocks, you can tweak your cap combination in such way that you have 80% equity allocation in large caps and only 20% in mid caps. That flexibility you do not get in case of multi-cap funds.
4. Specialization and Fund manager DNA: This is perhaps the one point that makes a case against multi-cap funds. Fund management, typically, is a case of DNA. For example, some AMCs and fund managers have been very successful in managing large cap funds. Then there are some AMCs and fund managers who are extremely adept at managing mid can small cap funds. These are two different levels of specialization that is called for and a multi-cap fund actually tries to create a fund manager who is more generalized and less specialized. That is a major disadvantage of opting for multi-cap funds.
The bottom-line is that multi-cap funds give you the simplicity to the extent that they do not require any monitoring or active management from your side. It also provides inbuilt diversification without any effort from your side. However, multi-cap funds have two major shortcomings. Firstly, they do not have the ability to customize the product to your unique requirements and your allocation is dependent on the fund manager’s view. Secondly, managing capitalization classes is a specialized job and a single manager may not work well for large caps and small caps. If you can manage, then it is best to handle your large cap and mid cap allocations on your own rather than depend on multi-cap funds!