Do Flexi-Cap Funds Really Help To Diversify?

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.

One of the key factors that can help you tackle the impact of volatility in the stock market is the level of diversification in the portfolio. Besides, the level of exposure to different market segments determines the balance between risk and reward. Considering the importance of having a well-balanced portfolio, flexi-cap funds can help you create one. A flexi-cap fund has to invest a minimum of 65 per cent of its assets in equity and equityrelated instruments. However, there is no minimum threshold for investments in Large-Cap, Mid-Cap and Small-Cap stocks. 

To get more clarity on this, it is important to understand the definition of large-cap, mid-cap and small-cap stocks. The top 100 companies in terms of market capitalisation are considered as large-caps. Those from 101 to 250 are mid-caps and the ones from 251 onwards are small-cap companies. Broadly speaking, as an investor, you have to make two important decisions. While on the one hand you need to work out asset allocation based on your time horizon and risk profile, on the other hand you must work out allocation to different market segments in a manner that it doesn’t take you beyond your defined risk-taking ability.

It is heartening to see an increasing number of investors following a goal-based investment approach that allows them to determine their time horizon for each of the goals. This process goes a long way in deciding not only the asset allocation but also prepares them to tackle the impact of volatility. However, deciding the right mix of exposure to different market segments, as well as rebalancing it, still remains a challenge for a majority of investors. Here, flexi-cap funds can play an important role.

Remember, the fund manager of a flexi-cap fund can maximise returns and minimise the volatility risk by making changes in the allocation to different segments depending on the emerging scenario in the stock market. Moreover, the rebalancing in allocation to different segments becomes a tax-efficient exercise as you become liable to pay capital gain tax only when you decide to either redeem or switch. However, considering that most of the flexi-cap funds have a bias towards large-cap stocks, the question that needs to be addressed is whether these funds actually help you diversify adequately. 

Presently, large-cap stocks dominate the portfolios of most of the flexi-cap funds. In fact, many of them have an exposure of more than 80 per cent in large-cap stocks with a very low exposure to small-cap stocks currently. For investors who don’t manage their portfolio very actively, having a bias towards large-cap stocks works well, especially in the current market situation. Besides, it can be expected that once the economy and the stock market stabilises, fund managers will increase allocation to mid-cap and small-cap stocks in a manner that investors benefit from the prospects of these two segments while still having a bias towards large-cap stocks.

Investors often grapple with the issue of whether relying on holding a combination of large-cap, mid-cap and small-cap funds is a better idea than investing in flexi-cap funds. No doubt, for investors who have the wherewithal to decide allocation to equity as an asset class and to different segments within that, opting for a combination of large-cap, mid-cap and small-cap stocks can be a good idea. While doing so, investors get to choose the best funds in terms of portfolio composition and level of diversification for each of the segments. However, the temptation to invest aggressively in mid-cap and small-cap stocks and the inability to time the rebalancing between different market segments well can prove costly.