Flexible cap funds are back in the spotlight of investors. In August 2024, they recorded net inflows of Rs 3,513 crore, the highest among diversified equity schemes. With Indian stock markets at all-time highs and valuations at elevated levels, investors are turning to flexible cap funds as they want to trust fund managers to dynamically allocate across large-, mid- and small-cap stocks.
“Flexible-cap funds, with their inherent flexibility, are preferred because they can better manage risk-averse sentiment or volatility by adjusting the mix of large-, mid- and small-cap companies,” says Meenakshi Dawar, equity investment manager, Nippon India Mutual Fund.
Navigating the market cap spectrum
Flexible cap funds invest across market capitalisations with no fixed allocation limits. Fund managers have complete freedom to select stocks they find attractive. Data from the Association of Mutual Funds of India (Amfi) shows that 39 flexible cap schemes collectively managed Rs 4.29 trillion as on August 31, 2024.
“The strong inflows during the current volatile market are due to the fact that flexible cap funds offer the advantage of not being tied to fixed allocations across large, mid and small cap stocks. This flexibility to dynamically adjust portfolios enhances potential returns,” said Deepak Ramaraju, Senior Fund Manager, Shriram Asset Management Company (AMC).
Balancing risk and reward
Flexible cap funds allow maximum flexibility to fund managers. “Greater diversification through investment allocation helps balance the risk and reward of these funds. Historically, flexible cap funds tend to outperform in volatile markets because of this ease of spreading investments across the board,” says Varun Goel, Senior Equity Fund Manager, Mirae Asset Investment Managers (India). Today, many flexible cap funds have tilted their portfolios heavily towards large caps.
Ramaraju highlights that mid- and small-cap investments offer growth opportunities, while large-caps offer long-term stability.
Flexible capitalisation schemes are tax efficient. Rebalancing between large, mid and small capitalisation schemes on one’s own account creates tax liabilities.
Allocation may be distorted
Since the allocation is guided by the fund manager’s market view, there is a risk that there may be a mismatch between the investor’s desired allocation and the fund’s allocation to different market capitalizations. If the fund manager takes on a high exposure to mid- and small-cap stocks, it could result in a higher than desirable risk for the investor.
Who should invest?
Flexible cap funds are ideal for investors who lack the time or experience to manage allocations across different market capitalizations.
These funds have the potential to generate wealth over the long term. “Investors with a moderate risk profile and looking for long-term wealth creation should choose a flexible cap fund. Due to the balanced risk and reward profile, they tend to offer higher returns over a longer period,” says Goel.
Investors entering these instruments should have a minimum time horizon of five years. “Flexible cap allocations can be considered for the core equity portfolio. Investments can be made in lump sum and systematic (SIP/STP) modes,” says Dawar.
Before investing, check the fund’s historical allocation to market capitalisations. “Investors should assess the fund manager’s ability to effectively diversify and allocate across large-, mid- and small-cap companies during different market phases,” says Ramaraju.
For those who want to avoid fund manager risk, index funds that track the Nifty 500 or the BSE 500, which invest around 70 per cent in large-cap companies and the rest in mid- and small-cap companies, could be a better option.
“Depending on the risk appetite, around 25 per cent of equity investments can be allocated to flexible cap funds,” says Ramaraju.
First published: September 19, 2024 | 19:22 IS
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