Multi-Cap Funds A Versatile Option For Investors

Mutual fund investors in India have come a long way in the last few years. The consistent growth of mutual fund inflows since 2021, particularly through the systematic investment plan (SIP) route, is a testament to the maturity of the industry and the resilience of investors. Despite the equity market experiencing consolidation and offering limited returns in the past 18 months, there has hardly been any decline in the inflow numbers towards mutual funds. They have gained significant popularity among Indian investors thanks to a proactive regulator and stupendous efforts taken by the industry to educate the investors.[EasyDNNnews:PaidContentStart]

The Securities Exchange Board of India (SEBI), in an effort to de-clutter the categories and make it true to the level, has clearly defined different categories for investment. One such equity category that has gained traction last year is multi-cap funds. These funds offer a diversified approach to investing by allocating assets across Large-Cap, Mid-Cap and Small-Cap stocks. By definition, erstwhile multi-cap funds were free to invest throughout the market capitalisation. The primary goal of this fund was to alternate between large-cap, mid-cap and small-cap exposures.

However, a majority of the funds focused solely on large-cap stocks and had relatively minimal allocations to mid-cap and small-cap stocks over market cycles. Given this scenario, SEBI issued a circular in September 2020 requiring multi-cap funds to invest at least 25 per cent each in large-cap, mid-cap and small-cap stocks. This caused turmoil in the financial markets since investors expected a significant sell-off in large-cap companies along with increased purchasing in mid-cap and small-cap firms. This perception, however, was put to rest when SEBI approved a new mutual fund category called as flexi-cap in November 2020.

Flexi-cap funds are free to invest throughout the market capitalisation spectrum. Since a significant portion of the assets of multi-cap funds was invested in large-cap stocks (close to 80 per cent), most of the large-sized schemes converted to flexi-cap funds. For many investors who are still not very clear about this category of funds, the following paragraphs will help clear the air about this investment option. The article explores the performance of multi-cap funds, examining their returns over the past three months and one year, as well as their growth in assets under management (AUM), their percentage in relation to the total equity AUM and how this should gel with your overall portfolio.

The Returns Factor

Before delving into multi-cap funds, it is essential to compare their performance with other categories of equity dedicated mutual funds. The graph below provides the returns of various equity fund categories over the past three months and one year.

From the graph it is evident that multi-cap funds have delivered robust returns, outperforming most other equity fund categories, both in the short term (three months) and the long term (one year). Multi-cap funds have topped the returns chart in the Hybrid Fund category within equity with average return of 28.78 per cent returns in one year. Flexi-cap schemes and large-cap and mid-cap funds offered lower returns in the same period. Multi-cap funds offered an impressive 14 per cent average return in the three-month horizon. They have even performed better than their benchmark in the same duration. 

Such performance has led to rise in assets under management (AUM) of this category, which is an indicator of investor interest and confidence in a multi-cap fund category. The chart below showcases the growth in AUM of multi-cap funds in the last one year. 

The AUM of multi-cap funds has shown a consistent upward trend in the last one year. In June 2022, the AUM stood at ₹54,883 crore, representing 3.36 per cent of the total equity AUM of the industry. This figure gradually increased to ₹74,386 crore by May 2023, accounting for 3.52 per cent of the total equity AUM. Despite minor fluctuations, the growth trajectory remained intact, reflecting the sustained interest and confidence of investors in multi-cap funds. These numbers signify the attractiveness and potential of multi-cap funds as a preferred investment option within the equity market.

Performance of Multi-Cap Funds

Now let us delve into the performance of the individual mutual funds in this category. We have analysed the performance of direct funds which are open-ended. 

From the graph it is evident that HDFC Multi-Cap and Nippon India Multi-Cap funds have generated the highest total returns, both recording an impressive 30 per cent return. Between March 2022 and June 2023, these funds have delivered significant growth and outperformed many others in the multi-cap category. Kotak Multi-Cap, with a total return of 26.4 per cent, also exhibits strong performance, indicating favourable investment decisions within the portfolio.

Similarly, ITI Multi-Cap and Bandhan Multi-Cap have generated respectable returns of 23.1 per cent and 21.3 per cent, respectively, in the same period. Other notable performers include ICICI Pru Multi-Cap with a return of 21 per cent, Quant Active with 17.2 per cent, Aditya BSL Multi-Cap with 16.4 per cent and Invesco India Multi-Cap with 15.5 per cent. These funds have delivered satisfactory returns to investors. 

Most of the funds from this category have outperformed the benchmark.

Analysis of Funds’ Risk against Benchmark

Among the funds that we analysed, Quant Active exhibits the highest maximum drawdown at negative 20.67 per cent, indicating the largest decline experienced by the fund during the 15 months that were taken into consideration for the study. This is followed closely by Mahindra Manulife Multi-Cap with a drawdown of negative 19.47 per cent and Baroda BNP P Multi-Cap at negative 18.51 per cent. On the other hand, SBI Multi-Cap displays the lowest maximum drawdown of negative 12.65 per cent.

In terms of annualised daily volatility, once again Quant Active demonstrated the highest level of volatility at 18.4 per cent, implying significant day-to-day fluctuations in the fund’s returns. ITI Multi-Cap follows with a volatility of 13.8 per cent while both Nippon India Multi-Cap and HDFC Multi-Cap exhibit 13.6 per cent volatility. In contrast, SBI Multi-Cap displays the lowest volatility at 11.4 per cent. Comparing these metrics to the benchmark, Nifty 500, provides a basis for evaluating the funds’ performance. The benchmark itself experiences a maximum drawdown of negative 15.51 per cent and has an annualised daily volatility of 13.8 per cent.

Analysing the data, it can be observed that some funds outperform the benchmark in terms of maximum drawdown. Mahindra Manulife Multi-Cap, Baroda BNP P Multi-Cap and Sundaram Multi-Cap exhibit lower drawdown compared to the benchmark. However, other funds, such as Quant Active and Nippon India, have higher drawdown. Regarding volatility measured through annualised standard deviation of daily return, a few funds, including ITI Multi-Cap and Nippon India Multi-Cap, display higher levels of volatility compared to the benchmark. Meanwhile, SBI Multi-Cap showcases lower volatility.

Risk-Adjusted Return There are various ways to calculate the risk-adjusted returns such as the Sharpe ratio which measures the risk-adjusted return of an investment by considering the excess return earned above the risk-free rate per unit of volatility or risk. A higher Sharpe ratio indicates better risk-adjusted performance. Besides this, the Calmar ratio also measures the risk-adjusted return, which measures the risk-adjusted performance of an investment by comparing the average annual return to the maximum drawdown. Another important ratio in this category used by many is the Sortino ratio which evaluates an investment’s performance by focusing solely on the downside volatility or risk.

It considers the investment’s average return above the risk-free rate divided by the downside deviation, which measures the volatility of returns below a specified target or threshold. We assessed the performance of multi-cap funds and the benchmark Nifty 500 using the Calmar ratio, Sharpe ratio and Sortino ratio. Looking at the Calmar ratio, HDFC Multi-Cap stands out with a ratio of 1.69, indicating a relatively higher average annual return compared to its maximum drawdown. Other notable funds with strong Calmar ratios include Nippon India Multi-Cap (1.49), Kotak Multi-Cap (1.46), and ICICI Pru Multi-Cap (1.13).

These funds have demonstrated relatively better risk-adjusted performance in generating returns while managing downside risk. When considering the Sharpe ratio, HDFC Multi-Cap again showcases a high value of 1.7, implying a favourable risk-adjusted return compared to its volatility. Nippon India Multi-Cap (1.62) and Kotak Multi-Cap (1.48) also exhibit strong Sharpe ratios. These funds have managed to achieve higher returns per unit of risk compared to the benchmark Nifty 500, which has a Sharpe ratio of 0.83. Moving on to the Sortino ratio, HDFC Multi-Cap stands out once more with a ratio of 2.83, indicating superior risk-adjusted performance in relation to downside risk.

Nippon India Multi-Cap (2.73) and Kotak Multi-Cap (2.49) also demonstrate favourable Sortino ratios. These funds have exhibited the ability to generate returns while experiencing limited downside volatility. It is worth noting that some funds such as Sundaram Multi-Cap and Invesco India Multi-Cap display lower ratios across all the three metrics. These funds may have lower risk-adjusted performance compared to the other multi-cap funds in the analysis. When comparing the ratios of the funds to the benchmark Nifty 500, it is evident that several multi-cap funds have outperformed the benchmark across all the three ratios, highlighting their potential for delivering better risk-adjusted returns.

The table shows the results of a regression analysis of daily returns of multi-cap funds against Nifty 50, Nifty Mid-Cap 150 and Nifty Small-Cap 250 daily returns. The columns in the table represent the total returns of multi-cap funds explained by large-cap, mid-cap and small-cap indices.

For example, the first row shows that HDFC Multi-Cap fund’s total returns are explained by 31.4 per cent by Nifty 50, 42.4 per cent by Nifty Mid-Cap 150 and 15.5 per cent by Nifty SmallCap 250. The table shows that the mid-cap index has the highest explanatory power for most of the multi-cap funds. This means that the performance of these funds is most closely correlated with the performance of the mid-cap index. The large-cap index has the second-highest explanatory power for most of the multi-cap funds. This means that the performance of these funds is also correlated with the performance of the large-cap index, but to a lesser extent than the large-cap index.

The small-cap index has the lowest explanatory power for most of the multi-cap funds. This means that the performance of these funds is not as closely correlated with the performance of the small-cap index. There are a few exceptions to this trend. For example, Quant Active fund’s total returns are explained by 13.9 per cent by Nifty 50, 12.1 per cent by Nifty Mid-Cap 150 and 63.1 per cent by Nifty Small-Cap 250. This means that the performance of Quant Active fund is more closely correlated with the performance of the small-cap index than the large-cap index or the mid-cap index.

Another exception is Sundaram Multi-Cap Fund. Its total returns are explained by 35.3 per cent by Nifty 50, 27.1 per cent by Nifty Mid-Cap 150 and 13.7 per cent by Nifty Small-Cap 250. This means that the performance of Sundaram Multi-Cap Fund is more evenly correlated with the performance of the large-cap index, the mid-cap index and the small-cap index. Overall, the table shows that the large-cap index has the highest explanatory power for most of the multi-cap funds. This means that the performance of these funds is most closely correlated with the performance of the large-cap index.

Multi-cap funds offer a diversified investment approach, allowing investors to benefit from the growth potential of large, mid, and smallcap companies. Multi-cap funds can be a valuable addition to your portfolio. 

Should you Invest in Multi-Cap Funds?

Multi-cap funds offer a higher level of risk compared to other categories of hybrid equity funds such as flexi-cap, large-cap and mid-cap among others due to their greater exposure to mid-cap and small-cap companies. However, when considering downside risk management in relation to their benchmark, the Nifty 500 Multi-Cap 50:25:25 TRI, multi-cap funds perform well. It’s important to note that multi-cap funds may not be suitable for all investors. Investors who already have investments in large-cap or large-cap-skewed funds and are seeking exposure to mid-caps and small-caps may find multi-cap funds appealing.

Similarly, individuals who desire exposure to mid-caps and small-caps but are hesitant to invest in dedicated mid-cap and small-cap funds separately can opt for multi-cap funds. On the other hand, investors with a conservative risk profile are advised to avoid multi-cap funds and consider flexi-cap funds instead. For those with an aggressive risk profile, it is recommended to bypass multi-cap funds and invest directly in mid-cap and small-cap funds. As a result, multi-cap funds are best suited for investors with a moderate risk tolerance who seek a balanced exposure across different market segments. It’s crucial for investors to assess their risk tolerance and investment objectives before deciding on the most suitable fund category for their portfolio.

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