How multi cap funds balance risk and return through diversification

Investing in the financial market can be overwhelming, especially with the wide range of investment options available to Indian investors these days. If you are an investor who wants to diversify your portfolio while maintaining a balance between risk and reward potential, multi cap funds can be a suitable option. They provide investors with exposure to companies of different market capitalisations with the aim of potentially creating wealth in the long term while navigating various market conditions.

Let’s understand what multi cap funds are, the risks involved and factors to consider before you invest in multi cap funds.

• Table of contents

1. What are multi cap funds?
2. What are the risks associated with investing in multi cap funds?
3. What is a suitable time to invest in multi cap funds?
4. 4 factors to consider before you invest in a multi-cap fund

What are multi cap funds?

These are equity funds that invest in companies across the market capitalisation spectrum – i.e., large cap, mid cap and small cap. This gives them a better risk-return balance than equity funds that focus on a specific market segment. As per regulatory norms, multi cap funds must invest a minimum of 75% of their corpus in equities, with at least 25% allocation each to large, mid, and small cap stocks. Here are the features of these stocks:

• Large cap stocks: These are the top 100 companies on the stock exchange based on market capitalisation. Typically, large caps are well-established companies with stable earnings, offering relatively lower volatility and the potential for steady returns in the long term.
• Mid cap stocks: They belong to growing companies that have the potential for better returns in bull markets but come with greater risk. These are companies listed 101 to 250 on the stock exchange based on market capitalisation.
• Small cap stocks: These are emerging businesses that may offer significant growth potential if they become big players but also carry higher volatility. These are companies listed 251 onwards based on the market capitalisation.

What are the risks associated with investing in multi cap funds?

While multi cap funds offer diversification benefits, they also come with inherent risks such as:

• Market volatility: Since multi cap funds invest in small and mid cap stocks in addition to large cap stocks, they can experience significant fluctuations in value due to market swings.
• Investment strategy of the fund manager: The performance of a multi cap fund depends largely on the fund manager’s ability to allocate assets effectively across different market segments.
• Liquidity concerns: Small cap and mid cap stock investments in these funds may have lower liquidity compared to large cap stocks, especially during volatile market runs.
• Sectoral and economic risks: The performance of multi cap funds can be influenced by broader economic conditions, sector-specific risks, or changes in government policies.

What is a suitable time to invest in multi cap funds?

If you want to work towards potential wealth creation with multi cap funds, these are some things to consider when timing your investment:

• During market corrections: If you invest in multi cap funds when markets are down, it can help you buy at low prices and benefit from growth opportunities if the market recovers.
• For longer investment horizon: Such mutual funds are suitable for long investment horizons. Typically, an investment horizon of 5 years or more is suitable for multi cap funds. This allows you to typically ride out market volatility. Alternatively, you can start a Systematic Investment Plan (SIP) to invest gradually and mitigate the impact of volatility.

4 factors to consider before you invest in a multi-cap fund

• Fund performance: Though an important factor, it is important to contextualise fund performance when selecting a mutual fund. Newer mutual funds may not have performance data, so look at their investment strategy, portfolio details and fund manager’s expertise. Also, do remember that past performance may or may not be sustained in the future.
• Investment goals, investment horizon and risk appetite: You must ensure that the fund aligns with your financial objectives, investment horizon and risk appetite. A longer investment horizon of 5 years is recommended for equity mutual funds.
• Expense ratio: A lower expense ratio translates to higher net returns. Compare different funds across multiple parameters, including the expense ratio, before making an investment decision.
• Experience and profile of the fund manager: Fund managers invest your money in different stocks to get you better returns from investment. They keep changing asset allocation to effectively navigate market shifts. A skilled fund manager can make significant difference to your return potential in the long term.

conclusion

In conclusion, multi cap funds can offer a diversified investment option for those seeking long-term wealth creation potential and a better-risk reward balance than equity funds investing in a single market capitalisation. However, understanding the risks, investing with a long-term perspective, and choosing a suitable scheme after careful evaluation are important steps to optimise the return potential from multi cap funds.

FAQs

What are multi cap funds and how do they differ from other equity mutual funds?

Multi cap funds invest across large cap, mid cap, and small cap stocks and offer diversification and to investors. This allows them to tap into the growth potential of different market caps in various market conditions or to mitigate downside risk through large cap investments.

How do multi cap funds balance risk and reward in different market conditions?

Multi cap funds balance risk and reward as they invest in large, mid, and small cap stocks. Large cap stocks provide relative stability and lower downside risk, while mid cap and small cap stocks can offer higher growth potential in bull markets.

Are multi cap funds suitable for long-term wealth creation?

Multi cap funds offer a diversified portfolio across large, mid, and small cap stocks and helps mitigate risk while capturing growth opportunities across the market capitalisation spectrum. This can make them suitable for potential long-term wealth creation.

What factors should investors consider before investing in multi cap funds?

Here are a few factors of importance to investors.

• Fund performance: Analyse historical returns across market cycles (if available) to gauge the fund performance. However, do note that past performance may or may not be sustained in the future.
• Expense Ratio: A lower expense ratio is desirable since lower costs mean higher net returns.
• Expertise of the fund manager: Fund managers choose stocks based on their experience and regulatory requirements. The decision-making skills of the fund manager influence return potential over time.
• Risk tolerance and investment horizon: Multi cap funds come require a high risk appetite and a long investment horizon is recommended.

How do fund managers allocate assets in multi cap funds to optimise returns?

As per regulatory requirements, multi cap funds need to allocate at least 25% of their portfolio to large, mid and small cap stocks each. Thus, 75% of the allocation pattern is fixed. The remaining 25% can be deployed by the fund manager based on their strategy and market conditions.

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.