When you put your money in an equity mutual fund, do you also tell the fund manager which stocks to buy? No, and yes. While investors don't give any instructions, a fund with a fixed investment mandate picks only those type of stocks.
For instance, a large-cap fund will invest only in index-based heavyweights and other blue chips. You won't find a small-cap company in its portfolio. This is why large-cap funds tend to move slowly and surely compared with other categories. Similarly, a small-cap fund will focus on smaller companies, forever hoping to zero in on the next Infosys that will turn it into a multibagger.
Multi-cap diversified equity funds have given higher returns
On the other hand, multi-cap funds invest across the entire spectrum of stocks, starting from large-caps all the way down to small-caps. They have a flexible mandate, which helps them pick winners from across market capitalisations.
"Wealth creation happens when the fund management process has flexibility. Multi-cap funds have an in-built mandate to capture the upside across the market spectrum," says Om Ahuja, head of private wealth management and strategy at Emkay Global Financial Services.
The performance of multi-cap diversified equity funds bears this out. In the past three and five years, this category has given higher returns than those from other categories of diversified funds.
Multi-cap funds are the best long term investment option for creating wealth
As companies belonging to different market segments demonstrate different levels of volatility and returns, it is best for investors to hold stocks of varying market capitalisations.
"Multi-cap funds provide the investors with the offer to build a diversified portfolio by giving them access to all kinds of equities," says KN Sivasubramanian, chief investment officer, Franklin Templeton Investments.
For instance, in the past one year, mid- and small-cap funds have done exceedingly well, but in the long-term, multi-cap funds have consistently outperformed the other categories. "Multi-cap funds are the best investment option for creating wealth in the long term," points out Ahuja.
Work in all market conditions
The flexible mandate of multi-cap funds gives them access to greener pastures in all market conditions. At the beginning of a bullish phase, it is usually the large-cap bellwether stocks that do well. Midway through the bull run, these large-cap stocks reach high valuations and the focus of the investing community shifts to mid-cap and then finally small-cap stocks.
"Retail investors cannot gauge which part of the market will perform well-large-caps, mid-cap or small caps. By investing in multi-cap funds, they can gain in all market conditions," says Saurabh Jain, associate vice-president, retail equities research, SMC Global Securities.
In financial crisis, a multi-cap fund will be able to bear redemption pressures The 'go anywhere' strategy works well during downturns as well. "While a given set of conditions may not benefit one part of the multi-cap fund portfolio, it could benefit the other, thereby creating a counter-balance effect that generates long-term results," says Maneesh Kumar, managing director, Burgeon Wealth Advisors. When the bears are on the prowl, small-cap and mid-cap stocks fall harder than large-caps. Multi-cap funds are able to cushion themselves better than funds which are focused only on these vulnerable segments.
A deft fund manager can realign the fund's portfolio rapidly and thus benefit from the changing market mood. "Besides, in a black swan kind of a scenario, such as the financial crisis that we experienced in 2008, a multi-cap fund will be able to bear redemption pressures better compared with a mid- and small-cap fund as it is likely to be more liquid," adds Kumar.
We looked at the performance of the top 15 multi-cap funds during a bull phase and a bearish phase. Except for three instances out of the 30 observations, the multi-cap funds outperformed their benchmarks. Most of the funds outperformed their benchmarks in both the bear and bull phases.
"Multi-cap funds have delivered in all kinds of environments and market sentiments. It is true especially for the top performing ones in the category," says Vinod Sharma, head of private broking and wealth management at HDFC Securities. Apart from the freedom to invest in stocks of any market capitalisation, multi cap funds are also not shackled by any particular investing style.
These funds can benefit from both value and growth investing, depending on their objectives. "This is because the fund manager can pick from a much larger population of stocks," says Sharma. For instance, Franklin India Flexi Cap Fund is a multi-cap fund and follows a bottom-up approach to stock selection.
The fund's investment objective is to provide investors with a blend of growth and value investment options. The focus is more on individual companies and their potential to create wealth over the long term.
Betting on the fund manager's ability
The fund manager's ability to select stocks is crucial to the success of a mutual fund. However, this becomes even more critical in case of a multi-cap fund. "Investing in a multi-cap fund is akin to investing on the fund manager's capabilities," says Jain.
This is because the risk levels of a multi-cap fund can rapidly change, which requires deft handling by the manager.
Not only does he have to monitor a larger universe of stocks, but the possibility of making the wrong choice widens due to the freedom granted to him.
If he fails to read the market conditions correctly or is not able to change the allocation of the fund's portfolio, the returns are likely to fall behind. The multi-cap fund manager must also manage his sectoral allocations well. Sectors tend to move in cycles and he should be able to change his allocations depending on the economic cycle. This is why multi-cap funds carry a higher risk than index funds or large-cap funds. Look up the fund manager's track record carefully before you invest in one.
Since multi-cap funds have a larger universe of stocks to buy from, their churn also tends to be higher than that of other fund categories. The average portfolio turnover of the multi-cap funds is 79%, while that of large-cap and mid- and small-cap funds are 73% and 64%, respectively. Portfolio turnover is a measure of how frequently assets were bought and sold in a fund by the manager during the course of a year.
The higher the turnover rate, the higher will be the transaction or trading costs for the fund. Although these costs are not included in the fund's expense ratio, they are paid for by the investors' money, not the fund manager's salary. Thus, funds with higher portfolio turnover eat away into the returns. Over the long term, this can affect the returns from the fund significantly.
The churn does not seem to be so abnormal
However, experts don't see this as a significant drawback as long as the fund is able to generate the returns that justify the higher costs. "The churn does not seem to be so abnormal," says Sharma.
Besides, churning depends on the style of investing as well. Both the DSPBR Equity and the Templeton India Equity Income funds are multi-cap schemes. While the former has a portfolio turnover of 216%, the latter's measurement is only 3.49% as it functions on value investing.
"Churning depends on the style of investment. Also, a higher portfolio-turnover need not always lead to higher costs. If the individual bets work, the gains can easily more than cover the trading costs," says Sivasubramanian.
Another drawback of multi-cap funds is that fund managers are somewhat reluctant to allocate a higher percentage of corpus to small- and mid-cap companies. Hence, they are not able to effectively capitalise on the USP of the category. "At the time of redemption pressure, it is difficult to exit mid- and small-cap stocks. Due to liquidity concerns, a multi-cap fund manager may exhibit a large-cap bias to be on the safe side," says Kumar. The non-availability of information could be another reason why the exposure to small-cap and mid-cap stocks is restricted.
However, die-hard fans of multi-cap funds defend the category. "Although one can contend that they could have been more aggressive, the superior returns generated by multi-cap funds belie these allegations. Besides, a rise in the ratio of small-caps in the overall allocation can augment the fund's inherent risk," says Sharma. Experts believe that it is too early to draw any inference about multi-cap funds. "Pure multi-cap funds are rather new in the Indian market. Hence, any evaluation would be unfair as the funds have essentially been around for one market cycle," says Sivasubramanian.
Should you invest?
Multi-cap funds are not of much utility for investors who understand asset allocation and base their investment decisions on it.
"It becomes difficult for investors who follow asset allocation principles to ascertain as to how these funds will fit in their portfolios as these virtually buy anything irrespective of capitalisation or sector," says Kumar. Asset allocation is the most important factor determining a portfolio's performance.
Multi-cap funds make an excellent investment option
Studies show that 94% of the portfolio's returns variance is determined by how funds are spread across asset classes. Only a small portion is determined by market timing and security selection.
Rakesh Rawal, head of private wealth management at Anand Rathi Financial Services, says that if you have a large portfolio, the asset allocation call is best taken between the investor and the financial adviser. In such cases, multi-cap funds lose their relevance. "However, if you have a small portfolio, then multi-cap funds make an excellent investment option," he adds.
Source: http://economictimes.indiatimes.com/quickiearticleshow/9258055.cms
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