Should Conservative Investors Consider Multi Cap Funds?

Conservative investors in India often turn away from equities, given their high-risk profile and significant short-term volatility. As a result, they may also miss out on the inflation-beating return potential that equities can offer over the long term.

However, there are ways to invest in equity mutual funds while mitigating risk—through limited, diversified allocations rather than concentrated exposure. Multi cap funds, which invest across large, mid, and small cap companies, are one such option, but they require careful consideration.

While not suitable for investors who seek capital preservation or minimal risk, multi cap funds can be considered by conservative-leaning investors who are open to a small, strategic exposure to equities in pursuit of long-term growth potential.

Let’s break down how these funds work, their potential benefits, the caveats, and where they may fit into a cautious or flexible portfolio.

• Table of contents

• What are Multi Cap Funds?
• Why Conservative Investors Hesitate with Equity
• How Multi Cap Funds Aim to Balance Risk and Return
• Key Benefits of Multi Cap Funds for Conservative Investors
• Tips for Selecting Multi Cap Funds
• Multi Cap Funds vs. Relatively Lower Risk Mutual Funds
• Taxation on Multi Cap Funds
• Who Should Invest in Multi Cap Funds?
• Is It a Suitable Fit for You?

What are Multi Cap Funds?

SEBI defines a multi cap fund as an equity mutual fund that invests at least 25% of its portfolio in large cap, mid cap, and small cap stocks. This fixed allocation rule distinguishes the category from flexi cap funds, which also invest in all three market caps but do not have minimum allocation requirements for each.

The objective is to give investors a single scheme gateway to the full market spectrum while avoiding over-concentration in a single size segment.

Why Conservative Investors Hesitate with Equity

• Volatility fear: Sharp drawdowns can feel punishing if you're used to the relative stability of fixed income funds or prefer capital protection-oriented avenues such as fixed deposits and savings accounts.
• Information overload: Tracking financial markets to identify investment options can be daunting.

These considerations can make a conservative investor pause before committing to equities.

How Multi Cap Funds Aim to Balance Risk and Return

The rule-based diversification of multi cap funds – where at least 25% of the portfolio needs to be allocated to each market caps – can make such funds less risky than pure small cap and pure mid cap funds. At the same time, they can capture wider market opportunities than pure large, mid or small cap funds.

However, the mandatory exposure to high-volatility segments like small caps makes multi cap funds high risk. Therefore, they may not be suitable for risk-averse investors who want minimal impact on capital.

However, if planned strategically with adequate risk controls, multi cap funds may suit conservative-leaning investors who prefer relative stability but are willing to accept some level of equity risk for potentially better returns over time.

Key Benefits of Multi Cap Funds for Conservative Investors

• Built-in diversification across the entire market capitalisation range eliminates the need to juggle several schemes manually.
• Regulatory guardrails ensure no fund strays too far into a single risky pocket, avoiding concentration risk.
• Potential for smoother performance cycles because fund managers can rotate between cap segments.

Risks to consider

• Small cap exposure is compulsory. Even with a core large cap holding, 25% in small caps can potentially introduce bouts of high volatility.
• Liquidity constraints in stress markets may make selling small cap holdings difficult due to lower trading volumes and wider bid-ask spreads, which may impact NAVs.

Tips for Selecting Multi Cap Funds

• Check rolling return consistency rather than single-point returns. Rolling returns show how a fund performed over different time frames within a broader period (like 3 or 5 years), giving a more rounded picture of performance consistency. In contrast, point-to-point returns only reflect gains between two specific dates. (Past performance may or may not be sustained in future).
• Review expense ratios relative to the category average.
• Assess risk metrics such as standard deviation and downside capture (a measure of how much an investment falls when the market falls).
• Align with your cautious investment strategy by starting with smaller SIPs before committing lumpsums.

Multi Cap Funds vs. Relatively Lower Risk Mutual Funds

Taxation on Multi Cap Funds

• STCG: Capital gains on units redeemed within 12 months are taxed at 20%.
• LTCG: Gains beyond ₹1.25 lakh after a 12-month holding are taxed at 12.5%.
• IDCW payouts taxed as per investor’s applicable slab rate.

Who Should Invest in Multi Cap Funds?

• Investors who want diversified mutual fund options but are not comfortable picking separate schemes for each cap size.
• Conservative-leaning investors with some risk appetite may consider a small, strategic allocation to a multi cap fund while keeping the rest in stable avenues.

Is It a Suitable Fit for You?

If you want to determine the suitability of multi cap funds, ask yourself the following:

• Are you willing to take on risk for the possibility of better potential returns in the long term?
• Do you accept the mandatory 25% small cap exposure?
• Can you stay invested for at least five years to potentially smooth out the impact of market cycles?

If you prefer to avoid all equity risk or require capital stability, a multi cap fund may not align with your investment profile.
However, if you are open to some volatility in exchange for broader equity participation, a multi cap fund can complement your strategy—as a small part of a portfolio that also has relatively stable debt funds or traditional investments such as fixed deposits, PPFs etc.

Conclusion

Multi cap funds can entail significant volatility, especially in the short term. This means they may not be suitable for conservative investors seeking capital stability and low volatility.

However, investors with a conservative mindset who are open to limited equity risk may consider such funds for their disciplined and rule-bound approach to diversification, if done thoughtfully and with full awareness of short-term risks.

Hold a long investment horizon, use SIPs to spread out investments and mitigate market timing risk and allocate only a nominal part of your portfolio to such funds. If you find that your risk appetite evolves or your comfort with equities increases, you may consider increasing your investments in such funds over time.

FAQs

Are multi cap funds suitable for first-time conservative investors?

They can be suitable only if the investor is comfortable with the mandatory small and mid cap exposure and can tolerate some volatility. It may be advisable to start with a nominal allocation and assess comfort before committing to a larger amount.

How do multi cap funds manage market volatility?

They rebalance back to the required 25-25-25 allocation, trimming overheated areas and reinforcing lagging ones, which may help mitigate volatility.

Can multi cap funds offer consistent returns?

No, mutual fund returns are market-linked. Additionally, equity mutual funds – especially those with exposure to mid and small cap stocks – can experience high volatility, especially in the short term.

What is a suitable investment horizon for multi cap funds?

At least five years, so that each cap segment has time to potentially outperform in its cycle.

How are multi cap funds different from balanced or hybrid funds?

Balanced or hybrid funds combine equity with debt; multi cap funds invest chiefly in equity but diversify across company sizes.