Why Market-cap classifications
India is a bustling marketplace, with over 7,462 companies listed on the National Stock Exchange and Bombay Stock Exchange together. To make investing easier, these companies are segregated into different categories. Market capitalization is one of the most common investment strategy used to group companies by size. Based on the value of all the company’s outstanding shares, in other words, its market capitalization, there are 3 primary categories:
- Large Cap – market cap of ₹20,000 crore or more
- Mid Cap – market cap is between ₹5,000 crore and ₹20,000 crore
- Small Cap – market capitalisation of up to ₹5,000 crore
Other than the market capitalization each of these categories has distinct features related to how they move on the market during bull or bear markets.
Large-cap companies are stable companies that have established businesses, and strong balance sheets. These companies are able to weather market volatility better. But their growth is also slow and steady given their proportion.
Mid-caps are companies with the potential to become large caps and have a higher room to grow faster than large caps. Their balance sheets may be vulnerable to high debt, market volatility, and extended recessions.
Small-cap companies are smaller and more nimble companies that are still figuring out their addressable market and growth. These companies are most vulnerable to volatility and overall a riskier investment than large or mid-cap companies given their balance sheets might not be strong enough to weather extended market swings.
What is a Multi/Flexi-cap Fund Investment Strategy?
As an investor, given a moderate risk profile, it would be detrimental to place all your eggs in one of these baskets. An investor may rake in high profits by investing heavily in small caps but the risk of loss of capital is high when things turn south.
On the other hand, investing in large caps might help the investor get stable returns along with dividends, but the capital appreciation from these stocks will not be stellar.
Though mid-caps bring forth the best of both worlds, their sway is very high due to institutional investors pushing and pulling investments from these companies based on market sentiment.
So how does an investor craft the perfect investment that is a mix of high growth rate and stability?
Flexi-cap or multi-cap funds can provide an answer! The terms “Multi Cap” and “Flexi Cap” strategically mean the same but do have a difference in terms of investment, diversification & regulation.
What is a multi-cap mutual fund?
Multi-cap funds diversify their equity investments by investing a minimum of 25% each, in large-cap, mid-cap, and small-cap stocks. This is a minimum requirement by SEBI, and the fund manager is not privy to making changes to this ratio. The remaining 25% is at the discretion of the fund manager to allocate to either large, mid, or small caps.
Due to this mandated allocation across stocks with different market capitalizations, multi-cap funds are much safer and more stable than mid- or small-cap funds.
What is a flexi cap fund?
As opposed to multi-cap funds, there is no fixed allocation investment rule in Flexi Cap across market capitalization. The overall rule is that 65% of investments need to be in the equity asset class.
There is no investment limit in Flexi Cap across all three caps. Fund managers can make an allocation to equities as per the requirements and risk profile of the investor class.
Let’s take an example of flexi-cap vs mid cap fund:
Flexi-cap funds are diversified across the stocks that fall under large, mid, and small-cap. Mid-cap funds invest in stocks that are part of the mid-cap category only.
Flexi-cap funds are able to ride out market volatility much better due to the diversification of their investment basket. The allocation among the asset classes and market cap stocks can be based on the investment strategy and the risk profile of the investor class investing in the fund.
Who should invest in multi-cap/flexi-cap mutual funds?
The next obvious question that comes to mind is: “Is a flexi-cap fund good?” or “Is a multi-cap fund good?”
Flexi-cap funds are ideal for non-aggressive investors with a moderate risk profile. The funds, owing to their very nature, are diversified. The investments in large caps provide the necessary stability to the portfolio, while the allocation to small and mid-caps provides growth.
The strategy for investment and performance is made for a long-term view. Investors must consider their risk profile, investment horizon, and the fee structure of the fund.
The next time someone asks you for the best mutual funds to invest in, do include multi- and flexi-cap funds in your suggestions.
What is the Nifty 500?
The Nifty 500 is an index brought to you by the NSE. The index measures the performance of the market by putting together a sample of 500 of the largest companies across different segments (large, mid, and small-cap companies). The NIFTY 500 Index represents about 96.1% of the market capitalization of all stocks listed on the NSE (March 29, 2019).
In the Nifty 500 index, the total weight of each size segment (large, mid, and small-cap) is based on the total free float market capitalization of all stocks falling within that size segment.
The Nifty 500 index and its constituent stocks form the basis for other indexes too, like the Nifty 500 Multicap Index.
The Nifty 500 is a great benchmark when it comes to multi-cap stocks. Investors in multi-caps use the Nifty 500 as their default benchmark. This is a good indicator of how the market is performing since it represents 500 out of the 7,462 companies listed in India across all market cap categories.
Even for Multi Cap Funds, the performance is always compared with this benchmark. Most actively managed funds try to beat the benchmark with their handpicked portfolios.
Put this way, the multi-cap and the Nifty 500 are highly representative of each other and have a relationship with the instrument-default benchmark. Flexicap and the Nifty 500 may or may not be representative of each other due to the freedom a fund manager has in the allocation of funds among different market-cap stocks.
How has the Nifty 500 index performed?
The Nifty 500 has grown at 11.71% CAGR over the last 5 years. Considering returns for the last 2 years, from the pandemic that caused a crash in March 2020 to the rebound in the index considered on March 2022, the returns have been 56%!
The overall Indian economy is projected to grow at 6.1% in FY2023 and more so going forward as and if the global inflationary pressures and geopolitical tensions ease off.
The growth prospects for 500 of India’s largest listed entities are also looking promising.
Investors look to broad indexes as benchmarks to help them gauge not only how well the markets are performing, but also how well they, as investors of the funds, are performing.
In the latest news about flexi-cap funds, investments seem to be finding their way into flexi-cap funds more than multi-cap funds due to the volatile nature of the market in August–September 2022. Flexi-cap funds allow the fund manager to allocate more investments toward large caps as opposed to at least 25% each on small and mid-caps in multi-cap funds.
Conclusion
Market capitalization is a common way to categorize companies by size and risk level. Large caps are more stable and have established businesses, mid-caps have the potential for growth but higher risk, and small caps are nimble but riskier investments. To mitigate risk and achieve a balance between growth and stability, investors can consider investing in multi- or flexi-cap funds that diversify their equity investments across large, mid, and small-cap stocks. Multi-cap funds have a minimum allocation requirement set by SEBI, while there is no fixed allocation rule in Flexi Cap. Ultimately, the choice of investment strategy depends on the investor’s risk profile and investment goals.
