The Mutual Fund Show: Flexi-Cap Vs Multi-Cap Schemes
While multi-cap funds must have 25% each in small, mid and large caps, flexi-cap schemes offer flexibility.
While multi-cap funds are mandated to have 25% each in small, mid and large caps, a flexi-cap fund allows the fund manager to decide the weight for each of the three categories of stocks.
If investors have a “slightly higher risk” appetite, they should opt for a multi-cap fund instead of flexi-cap, Chintan Haria, head-product and strategy at ICICI Prudential, told BQ Prime’s Niraj Shah. “You can choose to be in multi-cap funds because mid and small-cap is going to be the core.”
However, if the investor wants to give the choice to the fund manager to keep moving between mid- and small-cap stocks as they become expensive or cheaper, then flexi-cap funds would be the right option, he said.
However, Shweta Jain, founder at Investography, recommends flexi-cap funds for new investors who want low volatility and have a longer-term horizon.
“Whereas in a multi-cap, it is not necessarily aggressive, but it is aggressive compared to a flexi-cap. So, it's not as conservative where it has say 25-25-25 in each of the categories–large-cap, mid-cap, and small-cap,” she said.
Rushabh Desai, founder, Rupee With Rushabh Investment Services, also prefers flexi-caps to multi-caps given the “rigidity in the product” and since it involves higher risk.
“If someone wants to take a higher exposure towards a mid and small-cap, I prefer to have a separate portfolio or a separate mid and small-cap product. That would be much better in terms of risk mitigation,” he said.
View the full interview here:
Edited excerpts from the interview:
For people who are trying to figure out whether they should choose a flexi-cap fund or a multi-cap fund, what is your advice?
Chintan Haria: Since the introduction of flexi-cap as a category, it has opened up for manufacturers like us two avenues.
So, when we launched a flexi-cap fund about a year back, we launched it with India’s first model-based flexi-cap fund where we could move our mid-cap allocation and small-cap allocation from zero to 50, depending on the relative valuation of the large-cap and the mid-cap. Versus that multicap funds are mandated to have exactly 25% at least in mid-cap, 25% in small-cap and 25% in large-cap.
So, in multi-cap funds, it is essentially an allocation where you will be constantly, at least 50% in mid and small-cap. While in flexi-cap funds, the fund manager has the choice to move between zero to 100 literally, in any of these asset classes.
So, effectively from your perspective, if you have a slightly higher risk-taking ability, you can choose to be in multi-cap funds because mid and small-cap is going to be core.
So, when you are creating a portfolio and, in that portfolio construct, you want mid and small-cap to have a certain allocation in your portfolio at one point of time, then multi-cap fund is the right choice for you.
However, if you want to give that choice to the fund manager, to keep moving between mid and small-cap as they become expensive or cheaper, then that basically will come through to the flexi-cap fund.
Does your house have both? Would you reckon that over the slightly longer term, for the slightly higher risk appetite investor, a multi-cap fund has the potency to give slightly better returns than flexi-cap funds?
Chintan Haria: So, I would say that which fund does better than the other is ultimately determined on the stock-picking ability of the fund house and the fund manager managing the fund.
If I ignore that and say that over the next 10-15 years, mid and small-cap in India would do well and hence, having a fund which have a constant allocation in mid and small-cap may make sense. For the investor who's staying invested for the next 5-10 years, it could be true.
But if, for example, in a flexi-cap fund, we are able to basically time the mid-cap and small-cap allocation in a way, that does well. So ultimately, it's how well the fund manager does the allocation and more importantly, the stock-picking. Ultimately, it will come down to the stock-picking.
So, the volatility or the risk, as people perceive it, may be high in the multi-cap space.
We have both the funds–multicap as well as flexi-cap–which we have launched. The perceived risk can be higher in multi-cap space, but then ultimately, it's about the right stock-picking, which will ultimately deliver in the long run.
In both the funds, our endeavour is that the investor ultimately makes good returns. In the flexi-cap fund, we have a model-based approach while in multi-cap fund by regulation, there is a constant allocation which happens or a minimum allocation.
…Ultimately, it’s investors' patience, which will allow the investor to make money while the fund manager will obviously try to do a good job, in terms of picking the right stocks in the right spaces.
Let us talk about the Nifty 50 Equal Weight Index Fund. What is the nature of this product and what kind of investors should think of investing in it?
Chintan Haria: Ultimately, we have seen enough number of times that investors lose patience and come out of the fund at the wrong time. So, it’s first investors’ patience and remaining invested in it that matters, then the fund manager through the cycle will be able to deliver to the investor.
Coming to the NFO itself, the Nifty 50 Equal Weight of ICICI Prudential is one more addition to the overall bouquet that we are creating in the passive space.
Passive is gaining interest among investors and we do believe that in this ICICI Prudential Mutual Fund, we should have every possible investment avenue which an investor may want and fit in.
Large-cap market capitalisation-based indices like the Nifty 50, Nifty Next 50, Sensex 30 are already in place.
Apart from market capitalisation-based indices, we have seen some interest coming in even in equal weighted indices, especially since the last three years, because the last three years has seen markets becoming broad-based.
In broad-based markets–unlike between 2018 and 2020, where it was just the top 10 stocks delivering almost 80% of the returns—even within Nifty 50, a much wider participation has happened because auto has done well, metals have done well, and the smaller sectors have participated.
Keeping that in mind, we are very happy to launch the fund which actually has the same constituents as the Nifty 50, just that the weightages of the stocks are on the basis of their being equal weight.
So, there are 50 stocks, 2% weight at every quarterly rebalancing, that makes it 100% versus in a normal Nifty 50 Fund or Index Fund, you will have weightages on the basis of the larger stocks having a larger weight in terms of market cap. That's a simple concept.
When the market is broader-based, the Nifty 50 Equal Weight tends to do well. Here's one more opportunity for those who want to play this nuance in terms of their overall portfolio construct.
Has back testing or back modelling shown that the Nifty 50 Equal Weight performance tends to be better?
Chintan Haria: Yes, so the data of the index is pretty much there which showcases that in years like 2013, for example, when markets went through a bear phase, it's the broad-based or Nifty 50 that does better than the equal weight…
In other words, if you look at the 2020 calendar year, 2021 calendar year, and even 2022 calendar year, where the market breath has been stronger, or let's say, the Nifty 50, the sectors which have a smaller weight have done better, say sectors like autos or metals as the case was in 2021, the equal weight does better.
So, the back-testing data does show that when the market spread is significant, because essentially it is not the top weights which are emphasising or gaining measure of attraction, it's essentially diversified.
Just to give a highlight, in the last seven months, we have seen the technology sector go through a correction phase. By virtue of their having higher weights in the index, the Nifty 50 would have taken a bigger pain, while in the equal weight–because there are five stocks in the technology sector–the weightage was probably lesser. So, it's this rebalancing or this concept of having equal weight wherein the size of the stock is not impacting the overall return.
It's essentially the number of stocks that you have in that sector…
What about the other product which is the Auto Index Fund ? Why this particular theme? Is it trying to play something that you guys inherently believe as a theme will do well?
Chintan Haria: Yes, …over the last five to six years, we have seen Indian sectors, sectoral interest among investors increasing significantly.
We did launch the Bank index, the IT index, and in that continuation, we have the Auto index as well because India is the fourth largest auto market in the world and growing significantly.
As an ecosystem, almost everyone wants to take advantage of the fact that India is a growing market in autos.
With that thought in mind, we felt that as a sector it is large enough for investors to benefit from investing, those who believe that in the next five-10 years, India's auto sector is going to grow.
So, we are happy to offer the ICICI Prudential Auto Index Fund in terms of the NFO, which opens today and closes on Oct. 6.
What is the kind of risk associated with investing in these sectoral thematic funds, even if some of them might be slightly passive in nature?
Chintan Haria: So, in terms of sectoral or themes, the risk is associated with the cycles that each sector or theme goes through.
As we all know in the instant case, we had a 2013 to 2017 cycle in auto when the auto sector did extremely well. Then in 2017 to 2021, almost for four years–it got accentuated in Covid because obviously, the number of cars getting sold was lesser, semiconductor issues meant that car production was taking a hit–so, you have four years of underperformance happening or four years of stagnation in the auto segment.
Now that the pickup has happened, probably in the next two-three years, that tailwind does take the auto sector slightly in a positive territory.
Essentially, in sectoral or thematic schemes–be it active or passive–investors must know that there are cycles which play out.
We have seen the technology sector play out between 2018 and 2021 and now, being in a consolidation or correction phase.
The auto sector has done the reverse, from 2017 to 2021, it was in the correction phase and it has now started to bounce back.
So, to each investor, this is an opportunity to play the cycle as and when they do see that the cycle is turning and that's the objective.
The risks are that the themes or the sectors are going to be cyclical, and it is in the best interest of investors to understand those cycles and the risks associated with those cycles because the payoffs can be huge, but then the drawdowns can also be huge in thematic or sectoral themes.
Shweta, a Nifty 50 Equal Weight Index Fund is passive in nature so expense ratios are lower. But is this the right time to enter into an equal weight index investment opportunity and is ICICI’s product a good offering or are there other offerings available?
Shweta Jain: When somebody asks an advisor is this the right time to invest in equity, I think the answer is quite intuitive and advisors tend to say yes, the answer will be yes always.
But you have to stagger it. Is this the right time to invest in equal weighted funds? I think it's a great time to invest in equal weighted funds. Not because of anything else, but because there is a little bit of awareness, a little bit of education that is going on, with even the kind of innovative products that you are seeing in the passive space.
Having said that, equal weighted funds and other regular funds or passive funds, whether it's Nifty 50, there is, of course, a little bit of a difference. Would I recommend ICICI’s Nifty Equal Weighted Fund?
It is an NFO, people like the 10-rupee sort of tag. So, it becomes a little intuitive for them to invest in. But of course, there are other funds that are available as well. I think DSP introduced their equal weighted fund quite some time back and that's great. It's done really well in the past year especially and for the last many, many years if you take out data.
…For me, I would recommend investors who are new to invest in Nifty 50 rather than in equal weighted funds because it’s simple, costs are lower, and you are not really worried about anything else. But for people or investors who are a little bit more experienced, they can add an equal weighted portfolio to their existing assets, according to their asset allocation, of course.
Rushabh, what's your view?
Rushabh Desai: Equal weighted product is a great product in my view. It has a great diversification because it's not polarised towards certain stocks or certain sectors.
But you know, this product is going to perform well in a broad-based rally, it's not going to perform well in every cycle. If you compare them–because many large-cap funds have underperformed in the past few years–so this can be a good replacement towards an active large-cap fund.
But I did a small comparison between the Nifty 50 Equal Weight Index and Nifty 50 Index, which is a traditional index in the passive segment. I took out the data over the past 10 years and on a five to seven-year rolling return basis, only 18-19% Nifty 50 Equal Weight Index has outperformed the Nifty 50 TRI index.
And if you take the seven-year data, only 37% has outperformed the Nifty 50. So, if you go to see from 2012 to 2022, it is not even close to 50% on a five to seven-year rolling basis.
Now, if you go slightly on a longer duration side, which I took on a 10-year CAGR basis, on a daily rolling basis, it is coming to 50-50%.
So, for Nifty 50, traditional market cap index has done well 50% and 50% has done well in terms of the equal weight.
In my view, a combination of Nifty 50 and Nifty 50 equal weight would do a better job in terms of delivering returns, because …betting only on one particular strategy will not work.
As Shweta said, if an investor is new, I would bet on the traditional Nifty 50 but a combination of Nifty 50 and Nifty 50 Equal Weight would do a better job.
That just adds to the number of funds in the kitty. If on the Nifty itself, the investor is confused should I take a normal active large-cap fund or should I take a passive strategy, now you are telling them take a Nifty 50 passive strategy as well and an equal weighted index strategy and then we move on to mid caps, flexi-cap, multi-cap, small caps. Is there a need for that?
Rushabh Desai: Ultimately the constituents are the same. Nifty 50 and Nifty 50 Equal Weight–the stocks are the same, it is only the allocation that is changing.
Nifty 50 Equal Weight Fund is a smart beta strategy. So, if you want to outperform the Nifty 50, then there are better smart beta strategies available in the passive segment.
But, in Nifty 50 and Nifty 50 Equal Weight, even if two comes in one portfolio, will not make a big difference because the constituents are the same. It is only the allocation which is changing.
Is it a good time to have a thematic sectoral offering like autos? Is ICICI’s offering a good one or would do you reckon that there are other offerings which are out there and you have studied them and you like them better?
Rushabh Desai: The auto sector valuations are quite reasonable at this point of time. It's actually at par to their 10-year historical average. In terms of valuations, this is a good time to invest in the auto segment.
But I am comfortable investing in the auto stocks via active flexi-cap funds. I am not very comfortable going through index funds. There are a few reasons. This particular segment is going to be very cyclical and very volatile. Out of all of these companies, not every company is going to outperform. There will be certain stocks which will do well and there will be certain stocks which will not do well.
So, it’s better to leave it to the fund manager to decide which stocks are going to do well and which stocks are not going to do well. Also, another reason is I am quite bullish on the hybrid and electric vehicle space.
We are going to see a paradigm shift from fossil fuel vehicles to hybrid and electric vehicles in the next 10-20 years, going ahead.
So, out of all of these companies, you really have to see which companies are more focusing on the EV segment, how they are approaching it.
Also, another thing, consumer demand is also going to play a very important role.
The per capita income in India is still around $2,000, so everyone is not going to afford a vehicle, even though 7% of the GDP is contributed by the auto segment, and 49% through its manufacturing GDP. We are going to see a paradigm shift.
I am not very comfortable going through the index fund route. I would like to leave it up to the fund managers to cherry-pick the stocks which are going to be a multi-bagger in the future.
Shweta, what's your response to this?
Shweta Jain: Yes, I agree with Rushabh when it comes to certain sectors. I, too, want fund manager intervention, their expertise for my portfolio.
So, for large cap, I would choose passive funds, but for sectoral, thematic funds, small cap, I would choose fund manager expertise over the traditional auto route.
…But also, having said that, I am not a fan of sectoral and thematic funds per se because while valuations are looking good, I am not really a fan of exposing portfolios to sectoral thematic funds.
…one, you have to get the entry and the exit right, and secondly, you have to constantly eye whether your fund is doing well, your fund is sticking to a strategy, to what they should be doing. So, that's something that I would not recommend investors to sort of worry about.
If new investors want to invest in a certain sector, certain themes, I would definitely recommend that they stick to not more than say 10% of their portfolios, to do something which is more thematic in nature.
While this theme may do well, even the regular funds are going to pick up–your flexi-caps, mid-caps, all of them are going to pick up stocks in these categories. So, it's not that you are going to be left out if you are not going to invest in sectoral funds.
You will still have enough exposure through your regular funds, through diversified funds. Also, most people don't account for the volatility that happens with these sorts of funds. That is something that investors can get really worried with, and take wrong decisions and panic, so I wouldn’t recommend that.
Just to play the devil's advocate, for somebody who hears a lot of investing conversations and believes that she/he is willing to take the risks of underperformance but wants a higher exposure to autos and cannot research stocks on their own. Is this a product for such a person or are there other products available in the market for such a person who wants a higher exposure to autos?
Shweta Jain: If you really want high exposure to autos, you can actually go the Nifty Equal Weight route, because while you have 5% in auto in your regular Nifty 50, autos actually has double that in the Nifty 50 Equal Weight–it has almost 10%. So, I would recommend that to be a slightly smarter route.
Flexi-cap versus multi-caps: have you tried to do some analysis on what is better for what kind of investor?
Shweta Jain: Yes, when you are seeing inflows coming to a certain category of funds, you do tend to evaluate saying what's happening with this, why is there more fund inflow in this versus say another category which is quite similar in nature, at least prima facie if you see.
Flexi-cap has been attracting a lot of attention, a lot of inflows for the last year, and the reason is, it seems a little more conservative. You read between the lines because there is a certain flexibility that comes with the name itself–flexi-cap–so you are seeing more, for example, more investments in large-cap versus small-cap in this category. Whereas in a multi-cap, it is not necessarily aggressive, but it is aggressive compared to a flexi-cap. So, it's not as conservative where it has say 25-25-25 in each of the categories–large-cap, mid-cap, and small-cap. So it has that mandate and sticks to that mandate.
So, while on the face, it may seem like similar strategies, flexi-caps are seen to be a little more conservative and that's why it seems like a better bet for newer investors to start with, who want a little bit of small-cap exposure, who don't mind a little bit more volatility, who have longer-term horizons. So, because of that, I would recommend people to choose flexi-cap at the start.
Multi-caps are a great option too. But this is one of the reasons why I think it has attracted so much inflows.
Are there any flexi-cap funds that you particularly admire? It could be a few of many, but any one or two names that you particularly like?
Shweta Jain: So, one name actually. I think it's one of my favourites. So, the PPFAS Flexi Cap Fund is something that I really recommend for a long, long time now. I am really happy with the fund managers, with how it's doing, the strategy, performance, everything. It's hands down one of my go-to funds for any new investors to start off with.
Rushabh, the same question to you: flexi-cap versus multi-cap?
Rushabh Desai: I agree with Shweta. My favourite is the Parag Parikh Flexi Cap Fund as well. I prefer flexi-cap because of the flexible nature. Of course, there has been a little bit of drawback mainly because fund managers have been inclined more towards large caps.
In the flexi-cap funds, I would really like to see it be true to its label. But yes, there have been many funds which have been true to their label. Flexi-cap funds do also take exposure in international markets. That also is a great way to diversify geographically and in terms of currency as well.
Another reason why I am not a very big fan of the multi-cap segment is because of the rigidity in the product, because you have to invest 25% minimum in large, mid and small-cap each. So, you are actually investing like 50% in mid and small cap. So, in one particular product, 50% is a very big risk. It's not a great product in terms of risk mitigation.
If someone wants to take a higher exposure towards a mid and small-cap, I prefer to have a separate portfolio or a separate mid and small-cap product that would be much better in terms of risk mitigation.
But flexi-caps is one of the great categories as long as fund managers are able to flex across large, mid and small-cap segments. Optimum return can be generated in this particular category.
A lot of flexi-cap funds have large-cap exposure of late. Somebody made this comparison that instead of buying a large-cap fund, buy a flexi-cap fund since it has such a large exposure to large-cap pockets.
There is an investor who is risk averse, not very experienced investor. She has a time horizon of three years and wants to create a portfolio for herself.
Rushabh, create a portfolio which is not very complex, which has got three or four products for this investor. What should she do ?
Rushabh Desai: Three years is a very short time horizon for pure equity.
In terms of three years, I would go for Dynamic Asset Allocation Fund, also known as Balanced Advantage Fund. That is a good way to diversify and you are letting the fund manager decide to shift from debt to equity based on valuations. It is tax-efficient as well.
So, Dynamic Asset Allocation Fund for a three years’ time horizon, for average age, average income, it's a very simple product. Again, it is very important to choose the right style and the right product. So, pro-cyclical strategy is little bit for an aggressive investor who can stomach volatility and counter-cyclical strategy is something for a moderate or a little bit conservative investor within the back category.
So, you would rather stick to the Balanced Advantage Fund category as a whole because it gives an optimum mix of sorts.
Rushabh Desai: Exactly, that is what I am recommending. One can diversify within the Balanced Advantage category, have some three-four funds. That should do the job.
Not an exhaustive list, but any two or three funds that you like in that category?
Rushabh Desai: So, DSP Dynamic Asset Allocation Fund is true to its label and it’s a counter-cyclical strategy. That is something what I like in terms of conservative to moderate kind of investors.
Edelweiss Balance Advantage Fund is a pro-cyclical strategy. It is for a bit of aggressive investors who can stomach volatility.
Shweta, what do you advise this lady who wants to build this portfolio?
Shweta Jain: I would recommend a couple of options and I would do one with tax savings sort of nature for the simple reason that I like it when there is a lock-in of three years for new investors, because it helps them not panic and withdraw in the interim. So, I know the rules you made. So, you can say that I will not withdraw in the interim. But I would recommend a tax saver so that they stick to it.
I would recommend a Balanced Advantage Fund as well. It could be an Edelweiss Balance Advantage Fund. It could be a DSP Dynamic Asset Allocation Fund. I would recommend that they choose one of these two, not both, depending on who likes which name.
People also like the names. So, I would recommend one of these two.
I would like to add PPFAS as a flexi-cap fund, again because they like to see an international exposure. That's something that they can see.
Like I mentioned earlier, I like the fund, so these are three or four funds that they can look at and invest in.
Any preferences for the tax-saving category, Shweta?
Shweta Jain: I forever like the DSP tax saver. I like the Axis long-term funds as well. I think one of these two.