The Mutual Fund Show: Multicap Vs Flexicap Schemes
Tug of War (Source: BloombergQuint)

The Mutual Fund Show: Multicap Vs Flexicap Schemes

India’s market regulator allowed a new category of mutual funds last year—flexicap funds. That move was aimed at helping asset managers after changes in allocations reduced flexibility for multicap schemes.

A multicap plan needs to invest at least half the portfolio in mid and small caps. Flexicap funds are required to invest at least 65% in equities across market capitalisation without any restriction, giving fund managers more leeway.

Flexibility is what makes such funds a core product for any mutual fund investor as they provide the necessary diversification across market caps, said Rajat Chandak, senior fund manager at ICICI Prudential AMC. The asset manager will soon launch a flexicap fund.

“This is important as during downturns, the fund manager can take exposure to large caps and enjoy their relative safety, while over the longer term, a higher exposure to mid and small caps will help generate better returns,” Chandak said during The Mutual Fund Show.

ICICI Prudential Flexicap Fund has a mandate to invest up to a maximum of 50% in mid and small caps, he said. This would enable the fund generate risk-adjusted returns as the exposure to mid and small caps is capped, according to Chandak.

Prableen Bajpai, founder of wealth manager FinFix Research and Analytics, said while flexicap funds should be part of the core portfolio for any investor, there are enough existing options to choose from as opposed to a new fund offer. If ICICI Pru's scheme proves itself through a cycle or two, then investors can take exposure to it, she said, suggesting PPFAS Flexicap Fund and Canara Rebeco Flexicap Fund as “good choices at the current juncture”.

Bajpai also suggested equal-weighted passive investing strategy. It assigns equal weight to stocks in an index fund irrespective of market capitalisation. Three Indian indices offer such benchmarks.

  • Nifty 50 Equal Index

  • Nifty 100 Equal Index

  • NYSE FANG + Index (global)

And five schemes track these indices.

  • Principal Nifty 100 Equal Weight Fund

  • Sundaram Smart NIFTY 100 Equal Weight

  • DSP Equal Nifty 50 Index

  • Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund

  • Mirae Asset NYSE FANG + FOF

These schemes help reduce sectoral allocation and gives an investor a good mix of exposure to growth and value, Bajpai said. She suggested DSP Equal Nifty 50 Index Fund.

Watch the full interview here:

Here are the edited excerpts from the interview:

Rajat, why would you believe that among a plethora of options available, investors should choose flexi-cap funds at the current juncture?

RAJAT CHANDAK: We believe that flexi-cap should form a core part of any investor's portfolio today and there are a few reasons for it. One of it is the kind of flexibility that it offers the fund manager to allocate money across market cap categories—large, mid and small cap.

Flexi-cap funds can invest across market cap categories and the flexibility which is offered to the fund manager in managing the allocation is higher than any other category in the equity mutual fund space.

So if you look at categories like large-cap funds or multi-cap funds, or large and mid-cap funds, all of them have to meet certain minimum allocation criteria in various market cap buckets like large caps, mid caps and small caps. So, they don't have that much flexibility which a flexi-cap fund manager has who is running a flexi-cap fund.

Now, the other question which could arise is, how is that beneficial to its investors or customers, right? So, we believe that there are two parts to it. One is clearly these funds are much more balanced in terms of their allocation across market cap buckets—large caps, mid caps and small caps — and they're right there in the middle order in terms of risk and reward which they offer for the investors. Typically, we have seen how in volatile or turbulent times, large cap gave a good defense relative to mid caps and small caps so the fund also benefits out of having meaningful exposure in large caps. And at the same time, in the long run, because these funds also have some innovation in small caps and mid caps selectively, these funds also could benefit by having those exposures in mid and small cap. So that's one part of it in terms of how the risk reward can be balanced or they are in the middle offering good value to the investors. The second part is, it's important to understand that these market cap buckets also go through their own cycles, and if you look at for example periods like 2014 or 2017, mid caps and small caps outperformed the large-cap indices by a meaningful margin. So, a more than 20 percentage points kind of an outperformance which these mid-caps and small-cap indices delivered over large caps. A part of it reversed in 2018 where large-caps remained stable and these mid-caps and small-caps fell by 15-28% kind of a thing. So, the flexibility which the fund manager has—if any cap equity fund is managed dynamically and actively in deciding that allocation, how much it should be allocated. These are the key attributes and it's very well balanced as I said earlier. You can play across the market cap buckets, a broader market participation in the fund across large-caps, mid-caps and small-caps, and that in the long run I think would be beneficial for the investor. So, the flexibility which it offers and a wider participation across market cap categories are some of the key things. So, you have the best blend of both worlds—exposure in large-caps and mid and small-caps as well in the long run.

I believe you run the multi-cap portfolio in ICICI as well. For an investor who was probably choosing two or three equity funds, and one or two debt funds for their portfolio, must be wondering that why should they choose a flexi-cap fund over a multi cap fund or a flexi-cap fund over a large-cap fund or what's the kind of allocation that has to be done? Now if flexi-caps have been the core part of the portfolio. The question that naturally arises is are they better or worse using a flexi-cap product or a multi-cap product wherein the attributes might be similar. How would you respond to that?

RAJAT CHANDAK: These two products are in different categories in terms of their risk profile. SEBI came out with a circular last year, where they made two separate categories in terms of multi-cap and flexi-cap. Multi-cap funds have to have at least 25% allocation across all these three market cap buckets which means that at any point of time, the mid-caps and small-caps have to form 50% at least. There is no such restriction in flexi-cap, it is much higher than a flexi-cap fund so that we need to keep in mind, all investors need to keep in mind, obviously risk and reward go hand in hand. We have seen that in volatile times that small-caps and mid-caps tend to underperform the broader indices. So, in that context the risk and reward associated with a multi-cap fund is much higher than flexi-cap. The other thing is specifically because the fund managers have flexibility in a flexi-cap fund, if they dynamically and actively manage the allocation across these three market cap buckets it could really help the fund. We talk about asset allocation on a broader sense in terms of equity, debt, real estate and gold, etc., but here we are talking about asset allocation within equities where you can dynamically manage it or the fund manager themselves can effectively manage it for the investors.

You guys are coming out with this new fund as well, interesting timing, considering that the markets are sitting at new highs but there is a lot of, how do I say, concern or fear around what could happen in the second half after the rallies that we've seen thus far, and the second wave or the third wave or the delta wave and then the gamma wave all hitting across the world.

RAJAT CHANDAK: Actually, we believe that our economy is at the cusp of a good cyclical recovery which we can see over next three to five years. If you look at the recent past in the last five years, there have been some or the other hiccups or speed clickers which have come on the road of economic recovery. There have been various events like the demonetisation, GST implementation, the NBFC crisis or now Covid. A lot of these factors have played a role and constrained our economy in terms of achieving the full potential of GDP growth. We believe that a lot of these things are now behind us and a lot of good things are now falling into place. The government’s push in terms of infrastructure, PLI schemes which will give a boost to the manufacturing sector, we are already hearing the private capex cycle recovering, which was absent in the last two to three years, formalisation of the economy which is also visible in terms of how the GST collections have held up despite being various restrictions and in so many states in the last couple of months. A lot of building blocks have fallen into place which would bode well for the economy over the next three to five years and it will obviously have it’s rub off effects on the market. So, from being constructive on adding equities in this volatile phase, I understand that there are concerns in terms of rising inflation or bond yields would go up, or what will happen when the Fed would start their tapering down off stimulus, etc. But in those volatile times, we could make an opportunity of it in terms of deploying at that point of time when we see volatility. Over a three to five year period, it would be like a fully diversified, invested fund which would benefit off these economic cyclical recoveries which we anticipate in the next three to five years.

What should the concerns be for somebody who is looking at this?

RAJAT CHANDAK: I think there are two parts to it. One is like a standard disclosure, equities are a risky asset class and markets are volatile and in the short run it could impact the performance or returns of all the funds. So that's one aspect of it. Second is what we have decided for this fund specifically, is to have a good wide range of allocation for small-caps and mid-caps which is 0-50%. At this point of time, the valuation models are suggesting that to be a little cautious, let's say in terms of small-caps or mid-caps’ exposure. Let's say at this point of time, hypothetically, if we have slightly lower exposure in equities or in small-caps and mid-caps when markets continue to do well, for whatever reason, then obviously that's the risk we would be taking at this point of time on the upside. But apart from that I think it's okay, as I said it's a reasonably balanced product, a reasonably balanced category. We want to dynamically and actively manage it in terms of allocation between small-caps and mid-caps and which by the way, we would be guided by an in house market cap model which we have developed to guide us. As I discussed earlier that the decision of how much money has to be put in small-cap or mid-cap or large-cap is an important one, as we saw how in 2014, 2017 and 2018 the returns, the difference could be very large. So, it's an important decision and that's why to overcome at times this human emotion of greed and fear we have a built in a model which would guide us in taking the right decision, a difficult one but the right one, and we believe that our over long period of time it should help the fund and the investors.

Ceteris paribus, would you believe that your mid and small-cap allocation could be as high as 50% or more than that, or would you believe that at this point of time you will probably keep more large-caps?

RAJAT CHANDAK: There are two parts to it. One is what I said was the range in which we will play for mid-cap and small-cap is a large one, 0-50%.

You mean, not just for right now?

RAJAT CHANDAK: No, not just for right now and over a period of time it would range between 0-50%. We have placed this product just below multi-cap fund as a category because there you have to have at least 50% allocation towards mid-caps and small-caps. So, 0-50% is a wide range, which we have kept for the for the fund. The benchmark which is BSE 500 typically has around 25-30% of allocation in the mid-cap and small-cap space. Standing today, what our models are suggesting is to be overweight large-caps, probably 80% or plus in large-caps and 20% or less in mid-caps and small-caps. That's very intuitive because if you look at returns in last 15 months, mid-caps and small-caps have done much better than large-caps and their relative valuations or their relative attractiveness has gone down, versus what they were last year. That's where last year when SEBI came out with this regulation, we continued our multi-cap fund in that category. We thought and all the signals were suggesting that mid-caps and small-caps were relatively still attractive to large-caps at that point of time, so we added mid-caps and small-caps in the multi-cap fund and are now launching flexi-cap in this new category.

Prableen, would you choose flexi-cap funds at the current juncture?

PRABLEEN BAJPAI: Absolutely, I think flexi-cap funds definitely as Rajat said it does make a part of the core portfolio for any investor. But if that core has to be filled by an NFO, at this point, that's the question I think there's a huge amount of variety out there in the flexi-cap space and investors who do not have a flexi-cap fund and I believe that a lot of investors who've been investing for two or three years or more would definitely have a flexi-cap fund already in their portfolios, and if they don't then, we do have a huge range of 35-40 good flexi-cap funds out there and it definitely should be a part of the core portfolio, even at this juncture.

Prableen, would you believe that for an NFO to do well or for people to actually subscribe to an NFO, it might be helpful to wait and see how the fund does for a period of three to six months to one year or whatever and then put in the money, if that category is well discovered?

PRABLEEN BAJPAI: Absolutely. I’ll give an analogy here. It’s like you're going for some credential. So, going by any NFO which comes, it sounds very impressive. This is already a very well-established category because it was the multi-cap which is now the flexi-cap. So, why not put a chance? I mean there is no need to rush to go and kind of buy an ICICI Prudential flexi-cap at this stage, even for an investor who is looking to probably go and invest in this fund, I definitely feel that some amount of time can be given before you pick the fund. I personally believe that the performance during market downturns—that is a big testing time and it's good to go in for a fund where you've seen how the fund performs during drawdowns.

What about funds if you are in the liberty to tell us, maybe a few names which have done well in the drawdown, or you believe are good flexi-cap fund options anyway?

PRABLEEN BAJPAI: I'll give you two names here and just a disclaimer that it's just a suggestion and investors must use their own due diligence. One of them would be of course I think you're talking about flexi-cap so you can't go without naming Parag Parikh Flexi-Cap Fund. The first reason being that it has a beta of just about 0.74. So, it's going to go maybe not as high as the markets go up but then during drawdowns, there is limited downside to it as well and it was proved even during the fall of March 2020, the fund was down just by about 30% while the broader category by about 37-38%, and the turnover ratio, despite the fact that the category actually offers a lot of flexibility they have very well gone about to 7%. So it's not very dynamically managed but it also means that probably the stocks that they pick, they are high conviction stocks and they are sticking to them even during times when the situation may not be that great. A little concern here, the size of the fund has definitely grown a little bigger. It's about 10,000 crore but I think the space is such because you can move quite freely shouldn't be a concern also because they have a global allocation. The second name, I think can be Canara Robeco here. Again, it's a 4,000-crore fun, so agile and not too huge. Again, it has a beta of about 0.85 but less than one. I think this again has a good stock selection-based approach here so this can also be considered. A few other names PGIM has done very well recently but again, I think, some more time can be given before investors jump onto buying that product.

I think people have limited understanding of equal weighted indices, people have very limited understanding of passive strategies and therefore, it'll be lovely to hear from you, the importance of having or not having equal weighted passive strategies in one's portfolio and what should investors hope or expect when they invest into this category?

PRABLEEN BAJPAI: Of course passive investing is broadly that you tracking an index and the most popular indices whether it is India or globally are indices like S&P 500 or Nasdaq 100 or Nasdaq Composite or in India, Nifty 50 and BSE Sensex. Now all these are market weighted indices as in, as the price goes up with the stock, multiplied by the number of shares which are there in the market, the market cap goes up and so does the weightage. An equal weighted strategy just follows the parent in terms of the constituents. A Nifty 50 equal will have all the constituents which the regular Nifty 50 index has but it has a capping on the maximum weightage that is going to give to a stock and it's equal weighting. 50 stocks, 100 divided by 50, it would be a 2% allocation. If you're talking about Nifty 100 then it would be a 1% allocation to each stock and for investors in India, there is Nifty 50 equal, and Nifty 100 equal—these are the two strategies which are available for them and to take exposure outside India, the NYSE New York Stock Exchange Fang is one index which is, again, is the equally weighted strategy. The advantage here which I personally feel is that currently, I think most of us are holding a lot of active funds in our portfolios and any active fund whether it is from the mid-cap space, the multi-cap, the flexi-cap space will always have a proportion. Even if you're not holding a large-cap, you will always have a proportion of large-cap stocks in your portfolio because the fund has to maintain that amount of liquidity. I think it goes without saying that HDFC, ICICI, Infosys and Reliance will be a part of it. So, when you're going with the regular index fund, I feel the overall concentration of investor’s portfolio gets skewed towards these couple of stocks. Regular Nifty 50 has 68% weightage in the top 10 stocks and equal weightages brings you to 20% weightage.

It [equal-weighted strategy] reduces your overall concentration risk, makes it more diversified in terms of holding an index.

Even if you look at the performance, there have been years where there's huge polarisations where the Nifty 50 regular would outperform but then there have been years if you're looking from 2000 till about 2021, over these years 12 out of 21 years, Nifty 50 Equal has outperformed, if you're looking at calendar years and even in terms of rolling returns there have been phases where the Nifty 50 Equal has outperformed and during phases it has underperformed. So, I feel during times of broader market rally equally weighted strategy is definitely good and also from the point of view that most of us as Indians would have a combination of active and passive funds.

What are the options available?

PRABLEEN BAJPAI: Within India currently, if one has to track Nifty 50 Equal index, then we have the DSP fund which was launched in 2017 and very recently, Aditya Birla Sun Life closed their NFO, which is also an equal weighted strategy. So, we have two funds here and for tracking the Nifty 100, there are two funds again, one by Sundaram and one by Principal. Considering that they are undergoing this merger and they would be a single entity, I would say that investors at this point should avoid that strategy going with either of the funds because probably and eventually, they would merge the two and just continue with one of them. So, let things settle and then we can go for it. So, out of these four, I feel DSP Nifty 50 Equal is a good bet because it helps you reduce your sectoral allocations right from 37% which is a Nifty Regular 50, it comes down to about 21%. So overall sector weightage gets more diluted and I feel it's a good way of tracking the top 50 stocks because there's also that automated kind of rebalancing here. It's a good mix of let's say the growth and value strategies which we often talk about because the overvalued stocks during the quarterly rebalancing will be sold, there will be profit-booking and then the stocks which haven't performed that well, they would be bought. So, I feel it's a good amalgamation of these two strategies as well and better suited in combination with active fund portfolio and DSP Nifty 50 Equal is a fund that I think investors can look at. I’d like to add here that when we're talking about an equal weighted strategy, I mentioned the Mirae New York Stock Exchange Fund Plus which is again an equal weighted strategy but investors should be very careful that, although because these funds have a larger portfolio, 50 stocks and 100 stocks, the concentration risk actually reduces by going and taking the equal weighted strategy, in that particular fund because only 10 constituents are there, the concentration risk actually increases. So, they must be careful about that if they are looking at investing in that particular fund.

How should she or he approach his first mutual fund basket?

PRABLEEN BAJPAI: I feel, if you’re talking about equities, if the horizon is long, more than five years to 10-15 years, I think the first fund an investor should pick is an index fund and for them, it doesn't matter whether they're going for an equal weighted strategy or a regular fund because they would not have any other active funds as it is in the portfolio. So, either way it's okay, so passive fund tracking the large-cap space. Second, I feel that a flexi-cap fund again, can make your core basket. So, within the actively managed space, I feel a flexi-cap fund, and it can be complemented with a fund providing international exposure with a capping of about 15-20% depending on what's the objective of that investment. Of course, these decisions have to be based on the risk appetite and goals and other details but broadly I feel these are the three ones they can start off with, if it's a long-term portfolio. If it's for a lesser time period, let's say about five years and the risk appetite is high, they can do an SIP, take exposure in tranches again into an index fund and probably that can be complemented by an hybrid aggressive fund or a balanced advantage category fund for that five year kind of a period but only if the risk horizon is decent enough.

So, a balanced advantage fund according to you would carry a higher risk profile as opposed to a flexi-cap?

PRABLEEN BAJPAI: No, not at all, a flexi-cap will definitely have a higher risk. For a five-year period, I'm saying that's a simple index fund again, and it can be complemented with a hybrid or a balanced advantage fund where you do have a bit of debt allocation and generally for a first-time investor, again, I feel that an SIP or debt is also really great, because it helps to build a bit of a contingency fund or let's say a fund which can also give you the fear factor during a drawdown. As a new investor, it's easy to say that I'm okay with a 30% fall, it is not very easy to kind of digest that kind of a fall. So, I feel a small exposure in a debt fund can provide that kind of buffer. If you're not going in for a hybrid kind of a fund and for three-year period, a conservative hybrid category can be considered for a medium person with moderate risk appetite because equities are not something that ideally, we should be touching for a period of less than five years. So, there I feel a 15-20% exposure through the conservative hybrid category can be taken if the person's risk appetite matches.

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