Multi cap fund and multi asset allocation Fund - What you need to know

Mutual funds are known for their diversified and professionally managed portfolios. However, some mutual fund categories provide broader diversification than others. Multi cap funds and multi asset allocation funds are two such types.

Multi-cap funds are equity funds that are diversified across market capitalizations – they invest in large, mid and small-cap stocks. Multi asset allocation funds are hybrid funds that diversify across asset classes – typically, equity, debt and a third asset category such as commodities.

Both offer varied exposure but have key differences in risk profiles and return potential. Read on to learn more about the differences between multi cap funds and multi asset allocation funds.

• Table of contents

• Defining multi-cap mutual funds
• Understanding multi-asset allocation funds
• Comparing the core differences
• Multi-cap funds vs multi asset allocation funds
• Which fund is better?

Defining multi-cap mutual funds

A multi-cap mutual fund invests a minimum of 25% each in large, mid and small-cap stocks. The remaining 25% can be allocated in any market cap based on market conditions and the fund’s investment strategy. Fund managers may also choose to invest a small portion in fixed income instruments such as bonds or money market securities to mitigate risk.

The primary benefit of multi-cap funds is diversification across market caps to balance risk and return potential. Large caps provide relative stability to the portfolio, while mid and small caps allow better long-term return potential.

Multi-cap funds carry high risk since a significant portion is allocated to small and mid caps. However, the presence of large caps can result in lower volatility compared to pure mid and small cap funds.

Understanding multi-asset allocation funds

Multi-asset allocation funds invest across various asset classes like equity, debt, gold, etc. based on changing market conditions. SEBI mandates that these funds invest in at least 3 asset classes, with a minimum allocation of at least 10% in each.

Multi asset allocation funds aim to optimise returns for investors by tactically and dynamically shifting allocations between various asset classes while also curbing risk through diversification across these asset classes.

Their key benefit is this flexibility to alter the asset mix based on market outlook. This allows them to manage risk by diversifying across asset classes with varying risk profiles.

For example, when equity markets are subdued, the fund manager can reduce equity exposure and increase allocations to debt, gold or cash equivalents to mitigate downside risk. When equity markets seem favourable, exposure to stocks can be increased to benefit from their upside potential.

As a result, multi-asset allocation funds tend to have a lower risk profile than pure equity funds and better return potential than pure debt funds. However, most multi asset allocation funds maintain a typical asset allocation range. For instance, a multi-asset allocation fund may seek to maintain an equity allocation of more than 65% to tap into long-term growth potential and better tax rates than debt-oriented funds.

Comparing the core differences

• Asset mix - Multi-cap funds invest entirely in equities across market capitalisations. On the other hand, multi asset allocation funds invest across asset classes like equity, fixed income, gold, cash equivalents etc.
• Flexibility – Being dynamically managed, multi asset funds have greater flexibility to alter their asset allocation based on market conditions. In contrast, multi-cap funds have less flexibility as they must stay within the 25% allocation limit specified for each market cap segment. So, at least 75% of the portfolio must follow set guidelines.
• Volatility - Given their debt and gold allocations, multi asset allocation funds generally have lower volatility compared to multi cap and other equity focused funds.
• Returns - In bull market phases, multi cap funds can generate higher returns compared to multi asset allocation funds owing to greater for equity exposure. But in bear markets, multi asset funds may tend to mitigate risk more than mid cap funds owing to the dynamic allocation and presence of multiple asset classes.

Multi-cap funds vs multi asset allocation funds

Now let us do a detailed feature-by-feature comparison of multi-cap funds and multi asset allocation funds.

Risk profile

• Multi asset funds generally have a lower risk profile compared to multi cap funds since they diversify across equities, debt, gold and other asset classes. However, the exact risk level depends upon the equity allocation. The higher the proportion of equities in the portfolio, the greater the risk level.
• The fixed income component helps lower volatility and absorb shocks during market downturns.
• Multi cap funds carry higher risk as they remain chiefly focused on the equity asset class. Within equities too, they are more risky than large cap funds because the mid and small cap segments carry higher risk.
• However, the presence of large caps helps mitigate the risk to some extent compared to a pure mid-cap or small-cap fund.

Investment horizon

• The relatively higher risk profile of multi-cap funds makes them suitable for investors with longer holding periods.
• Since they are equity oriented, they are ideal for those with investment horizons of at least 5 years or more. This allows their growth potential to be realised over longer periods.
• Multi asset allocation funds that have an equity-heavy profile also benefit from a longer horizon, but it may also be suitable for moderately long horizons.

Expenses

• Given their singular focus on equities, multi cap funds may have lower expense ratios.
• Multi asset allocation funds tend to have higher expense ratios owing to dynamic management mandate and the need for expertise across asset classes.

Flexibility

• Multi asset allocation funds have more flexibility than multi cap funds owing to dynamic management.
• Multi cap funds have less flexibility as they need to stay within the 25% allocation limit specified for large, mid and small-cap segments. However, they have more flexibility than pure large, mid or small cap funds.

Which fund is better?

• For investors with a very high risk appetite and longer investment horizons of over 5-10 years, multi cap funds may be more suitable given their equity orientation and growth potential over an extended period.
• For investors with high risk tolerance and a medium-to-long investment horizon can consider multi asset allocation funds. However, the level of equity allocation in the portfolio can influence the risk profile and the suitable investment horizon.
• Younger investors in their 20s and 30s with higher risk capacity may prefer multi-cap funds to capitalise on long term wealth creation potential.
• Investors moving closer to retirement may opt for multi asset allocation funds given their relatively lower volatility and balanced approach.

Conclusion

The choice between multi-cap and multi asset funds depends chiefly on an investor's risk appetite, targeted return potential and investment horizon. Assess your specific investor profile and financial goals. Consult a financial advisor to determine which category of multi-strategy fund suits you better currently.

FAQs:

What is a multi cap fund, and how does it work?

A multi-cap fund invests across large, mid and small cap stocks with a minimum 25% allocation in each market cap segment. By combining stocks across market caps, it aims to mitigate risk and optimise return potential.

What is a multi asset allocation fund and what makes it different from other mutual funds?

A multi asset fund invests across equity, debt and other assets like gold based on changing market conditions. This dynamic allocation helps optimise the risk/return balance in evolving market conditions. The key difference versus other mutual funds is their diversification across asset classes rather than just equity or debt.

What are the key differences between multi cap funds and multi asset allocation funds?

The key differences are that multi-cap funds invest purely in equities, while multi asset allocation funds have a mix of equities, debt and other assets. Multi-cap funds have higher potential returns but also higher risk. In contrast, multi asset funds may be less impacted by volatility owing to their exposure to other asset classes. However, this may also lower their return potential compared to pure equity funds.

Which type of investor could find multi cap fund more suitable than multi asset allocation fund?

Aggressive investors with a very high risk appetite and an investment horizon of 5+ years may prefer multi-cap funds. Investors with slightly lower risk tolerance may opt for a multi asset allocation fund to diversify across equities, debt and gold.

How do the risk and return profiles of multi cap funds compare to multi asset allocation funds?

Multi-cap funds carry higher risk due to exclusive focus on equities across market caps. They can potentially generate higher returns in the long term but with significant volatility in the short or medium term. Multi asset allocation funds may offer a more relatively stable return potential, with lower downside risk.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.