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Investors fear that the bullish momentum in mid-and small-cap funds could see a reversal for a longer period.

Individuals are increasingly investing in multi-cap funds of mutual funds because of the volatility in the market. Data from the Association of Mutual Funds of India (Amfi) show net inflows in multi-cap funds touched Rs 3,569 crore in the month of September, the highest in the equity funds category.

Multi-cap funds invest in diversified stocks of large-cap, mid-cap, and small-cap across sectors. These funds capitalize on the opportunities across market caps and generate optimal returns for investors. Last year, the markets regulator changed the guidelines of investments in which multi-cap funds have to invest a minimum of 25% each in large-cap, mid-cap, and small-cap stocks.

This was done to ensure multi-cap schemes hold a diversified portfolio across large-cap, mid-cap, and small-cap companies and make the funds more diversified. Fund houses had to align their portfolios to these new limits by January 31, 2021. Before the new rules kicked in, fund managers of multi-cap funds invested a higher proportion in large-cap funds.

The Securities and Exchange Board of India (Sebi) had also introduced a new category called Flexi-cap which has flexibility in allocation across market caps and there is no restriction limit. This helped fund managers to avoid reshuffling the multi-cap portfolio and many existing multi-cap funds switched to the Flexi-cap category. At present, most Flexi-cap funds have a higher allocation to large-cap stocks.

Why multi-cap funds now?
Experts say that investors fear that the bullish momentum in mid-and small-cap funds could see a reversal for a longer period. Moreover, most new investors who have started investing in equities in the last 15 months have not seen a meaningful correction in the markets. In fact, since March 24, 2020, when the stock market hit a bottom because of the Covid-19 pandemic, the BSE Mid-cap Index has gained 166% and the BSE Small-cap Index has gained 223%. The 30-share Sensex is up 134% during the same period.

Investors are looking at multi-cap funds because they provide the stability and low volatility of large-cap stocks and higher returns of mid-caps and small caps, albeit high volatility. The funds are actively managed and whenever fund managers spot an investment opportunity in mid-cap and small-cap segments, the allocation towards them is increased making the funds a high-risk high-return investment proposition. Experts say as multi-cap funds will face higher volatility in the short term, investors must stay invested for a period of five years and above to gain significant returns.

Should you invest?
In multi-cap funds, fund managers maintain the allocation mandated by Sebi, and the rest 25% is dynamically allocated as per the fund house’s proprietary investment model to optimize the overweight of large-caps, mid-caps, and small-caps. Typically, the fund managers evaluate the business environment of the company, the valuation of the company based on fundamentals, and the capability of the management to execute and scale up the business.

Typically, during a bull market, multi-cap funds perform well as mid-cap and small-cap stocks generally soar higher than large-cap stocks. However, experts suggest that the decision on investing in a multi-cap fund should be based on the investor’s risk profile, financial goals and investment horizon.

Remember, investors have to pay capital gains tax as the investment will be treated as equity investments. The short-term capital gains tax will be 15% of the gains for a holding period less than one year and 10% for more than a year if gains are more than Rs 1 lakh in a financial year.