Flexi-cap funds: Will the flexibility given to fund managers yield result?

On November 6 last year, the Securities and Exchange Board of India (Sebi) came out with a circular which announced a new category of equity funds: Flexi-cap. This announcement came at an opportune time. It served both investors and fund houses well. Investors heaved a sigh of relief, as a new category of equity scheme provided exposure to companies of varied sizes.

But the journey to the creation of the flexi-cap category of equity schemes was not smooth and quick. It started with the rationalisation and categorisation of schemes announced in October 2017, wherein Sebi allowed one scheme each category — defined by market capitalisation along with other parameters. The regulator not only provided the definition of largecap, midcap and smallcap stocks, but also carved out the universe for largecap, midcap and smallcap equity funds.

Take for instance, the largecap equity fund. According to Sebi, a largecap fund is required to invest a minimum of 80 per cent into equity and equity-related instruments of top 100 companies by market capitalisation. This definition provided clarity to investors and fund managers and addressed the problem of duplication of schemes.

Investors began investing in multicap funds — schemes that invested in largecap, midcap and smallcap stocks. Multicap funds emerged as the largest category of equity mutual funds. As on March 31, 2020, multicap funds had assets under management of Rs 1.13 lakh crore.

Investors’ preference for multicap funds was not by chance, but a conscious choice. A well-managed diversified equity portfolio is a good prescription for long term wealth creation.

Since few have the skills or time to build one, many seek professional help and turn towards cost efficient means of mutual fund. Further, many wanted their fund managers to decide on allocation to sub-segments such as largecap, midcap and smallcap equities. And that is where the multicap became the preferred choice, as it offered fund managers the flexibility to invest in companies of varied sizes.

However, this heightened interest in multicap funds was shortlived.

On September 11, 2020, Sebi changed the allocation structure of multicap funds. It said that a multicap scheme must invest a minimum of 25 per cent each in largecap, midcap and smallcap stocks. The deadline for implementing this is January 31, 2021. The move was triggered by a disproportionate tilt of most multicap portfolios in favour of largecap stocks.

Midcap and smallcap stocks were grossly under-owned. This was not a true multicap portfolio. This change in asset allocation of these funds necessitated the creation of an equity fund category, wherein fund managers had the flexibility to invest in companies of varied sizes. To address this, Sebi introduced flexi-cap category on November 6, 2020.

A flexi-cap fund works in several ways. It allows a fund manager to invest in companies of all sizes without any restrictions. Fund managers can invest in high-growth, small-sized companies to benefit from high growth. But at the same time, it is not binding to do so, which helps manage liquidity better whenever required.

Even though the classification of stocks held changes, it does not impact fund managers’ investment decisions. A fund manager can stick to his conviction bets and benefit in the long term. In the grand scheme of things, a flexi-cap scheme helps fund managers gauge the relative attractiveness of markets’ sub-segments and allocate investments accordingly. Hence, it is vitally important that a flexi-cap scheme find its due place in a long-term investor’s equity portfolio.

(Akash Singhania is Fund Manager of Motilal Oswal AMC. Views are his own)

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