Over the past few weeks we discussed about large-cap funds and mid-cap funds. There is another category of equity funds that falls between these two – they are called diversified/multi-cap funds.
Within the equity funds space diversified or multi-cap equity funds are the go anywhere funds, i.e. these funds can invest in companies across market capitalisation segments. Historically large and mid-cap stocks had performed differently in different market cycles. There could be phases when large-caps outperform mid and small-caps and vice versa. In this regard, the large, mid and small-cap funds may not be able to take full advantage of all market conditions since they are constrained by their mandate to stay invested in their respective categories with only a small allowance to deviate. This is where diversified funds hold an edge. In diversified funds the fund manager has the leeway to switch holdings in the fund between large-cap, mid and small-cap stocks as he/she deems fit, based on market conditions. While diversified funds have the above said leeway, they mostly tend to have a large-cap bias, increasing or decreasing their mid-cap holdings by a small margin as and when conditions favour. For example, in the rallying mid-cap market of 2015, diversified funds too held a larger portion of midcaps to deliver higher returns than the large-cap category.
How FundsIndia classifies them
In the mutual fund universe, while some funds clearly stated that they are go-anywhere funds by using terms such as flexi-cap or multi-cap, it is not easy to infer whether a fund has a diversified strategy.
At FundsIndia we define diversified/multi-cap funds as those funds that have had an average exposure of 50% to 75% in large cap stocks, over a period of two years. The rest of the portfolio will comprise of mid and small-cap stocks. Though this is not a rule etched in stone, some may have different limits and range for the amount of exposure to large, mid and small-cap stocks.
Change in holding across cycles
As discussed earlier, depending on the market condition the fund manager has the leeway to move the investment across the cap curve. During uncertain times, or at times when the fund manager feels that mid and small-caps are richly valued and he sees value in large-caps, he can tilt greater chunk of the portfolio to be invested in large-cap stocks. This largely appears to be the case currently. At the same time when the fund manager sees greater opportunity in mid and small-cap stocks compared to large-caps going forward, he can make the changes to the portfolio accordingly. For example, a fund like Franklin India blue-chip, holds more than 80% in large-cap stocks under all circumstances. However, its sister fund Franklin India Prima Plus, a diversified scheme, holds large-caps anywhere between 55% to 70% (last 4 years) with rest of the holdings invested in mid and small-caps. Similarly as the markets have become more uncertain and volatile in the last couple of years, it can be noticed that the average exposure to large-caps across category have risen from less than 60% to greater than 60%.
Advantages and who can invest
One of the biggest advantages of these diversified funds is it reduces the need to keep track of multiple funds in the portfolio separately. Since these funds are invested across market-cap segments the need to maintain separate large-cap, mid and small-cap funds is eliminated. This helps provide a certain degree of stability to the portfolio.
During bull phases these funds tend to outperform large-caps by capturing some of the upside offered by mid and small-cap funds. And during bear phases these funds can contain declines better than mid and small-cap funds. Diversified funds are suitable for investors who wish to start with one fund and still invest across market-cap segments. It is also suitable for beginning investors and investors who are not sure of their risk tolerance levels.