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Multi-cap funds work for small portfolios

February 25, 2013 17:21 IST

Assume you want to start investing Rs 5,000 a month. It is likely the distributor would suggest you divide the sum in two types of funds - a large-cap and a mid- or small-cap. The pitch: As you would invest in two absolutely different funds and the latter could give exceptionally high returns or losses, large-cap funds would ensure stability in the portfolio.

However, there is a middle path, a multi-cap fund invests in large- and small-cap stocks. As the name suggests, multi-cap funds invest across market capitalisations. With a flexible mandate, these may choose the best across capitalisations. Many believe multi-caps can automatically capture an upside across capitalisations.

To some extent, multi-cap funds have proven this. In the past year, returns from large-cap funds were less than those from multi-caps. Of course, at 13.5 per cent, mid- and small-cap funds performed better than both categories. In the past five years, multi-cap funds have given more than 5.5 per cent yearly, against 3.5 per cent by large-caps. The returns of mid- and small-cap funds were at a par with multi-caps. In the past three years, the performance of multi-cap funds wasn’t as good as the other two categories.

Hemant Rustagi of Wiseinvest Advisors says, “Given the returns from multi-cap funds were between those from large-caps and mid- and small-caps, the funds hold higher high-beta stocks than blue-chip ones.” As multi-cap funds hold stocks from different market segments at varied market cycles, it is a good idea to invest in these funds, he adds. Typically, a bull market is led by large-cap stocks and investors shift focus to mid- and small-caps as large-caps’ valuations peak and the bull phase extends.

“Mid-caps are more volatile and, therefore, first-time investors cannot digest fluctuations in these stocks. Multi-cap funds temper this volatility with large-caps. So, it is prudent for new investors to invest in multi-caps,” says Sanjay Sinha of Citrus Advisors. This is also beneficial for those who don’t understand asset allocation and have small portfolios.

Multi-cap funds are able to provide a better cushion compared to funds focused on only one segment. Some feel taking the market-capitalisation approach isn’t the best option; the stock-picking method is better.

In the last year, the BSE Sensex and the National Stock Exchange’s Nifty gave about 10 per cent return each. Multi-cap funds returned an average of 12 per cent in this period.

There is no unique positioning for multi-cap funds. There is no definite distinction between multi-cap funds, flexi-cap funds (which allow shifting from one market cap to another, according to market conditions) and a Top 200 fund (that has a large-cap bias, with exposure to mid-caps). Experts say it is very difficult to suggest any of these.

“The performance of multi-cap funds is highly dependent on the fund manager’s nimbleness. It is akin to investing on the manager’s capabilities. Therefore, understanding multi-cap funds before investing becomes even more important. It is not a plain-vanilla large- or mid-cap fund. It plays all cycles within the market cycle. If the fund manager isn’t able to take quick calls based on the market movement, or takes a wrong call, your money is lost,” says Ramanathan K, chief investment officer at ING Investment Management.

A fund manager of a multi-cap fund has more stocks to choose from, compared to other fund managers. This increases the possibility of taking a wrong call. Also, sectoral allocations have to be managed. This is why multi-cap funds carry a higher risk than index funds or large-cap funds. And, risk levels might change according to a manager’s call. So, remember to track the fund manager’s record carefully before you invest in such a fund.

Mutual fund rating agency Value Research classifies multi-cap funds as those investing 40-60 per cent in large-caps. But Citrus Advisors’ Sinha cautions definitions of market capitalisation across fund houses might have wide disparity and investors could find themselves stuck in these funds if the definition is not etched properly.

Since multi-cap funds have more stocks to buy from, their churn tends to be higher than other fund categories. The average portfolio turnover of multi-cap funds is 79 per cent, and of large-cap and mid- and small-cap funds is 73 per cent and 64 per cent, respectively. Portfolio turnover is a measure of how frequently a manager buys or sells assets in a fund through a year. This means the churn could be higher in multi-cap funds and one would have to bear higher transaction or trading costs. “But these may not be very significant as long as the fund is able to generate the returns,” says Wiseinvest Advisors’ Rustagi.

Experts say multi-cap funds might not always allocate higher amounts to mid- and small-cap stocks and, therefore, not be able to make the most of a bull market. The low allocation in these segments is largely aimed at avoiding liquidity issues during redemption, as it is difficult to exit mid- and small-cap stocks.

If you understand asset allocation and base your investment decisions on this understanding, this fund is not for you. Experts say asset allocation based on one’s goals and risk appetite determines portfolio performance.

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