Multi-cap funds came into existence post a debate whether the funds, now classified as flexi-cap funds were really true to label. They are equity mutual funds that do not focus on a particular capitalisation category of companies but invest across multiple sectors and capitalisations.
While the fund managers have the freedom to invest across different market capitalizations, in September 2020, the Securities and Exchange Board of India (SEBI) revised its earlier norms and asked the fund houses to invest a minimum of 25 percent each in large-cap, mid-cap and small-cap stocks in their respective multi cap schemes. The remaining portion can be invested across market-caps or in debt and money market instruments.This makes them more diverse providing balanced exposure when compared to other traditional equity mutual fund schemes like Large or Mid-Cap funds.
Before this announcement, the fund managers in this category were free to choose stocks across market-capitalizations with no upper or lower threshold. There was thus no minimum or maximum restriction on how much they were investing in large, mid, or small-cap companies. While multi-cap funds can potentially outperform large-cap and mid-cap funds when the markets are on the ascent, they remain subject to market volatility because, at any given point, they must have 50 percent exposure to mid-cap and small-cap stocks.
Multi-cap funds thus offer flexibility to the fund manager to switch between stocks and accord additional or lesser weightage to stocks of a particular market capitalization depending on the fund manager’s reading of the market trend, in order to achieve higher returns. Like every equity category fund, multi-cap funds too have long-term investment horizon and tend to accentuate risk if invested for short time frames, given that market volatility has greater impact in the near term.
Taxation of multi-cap funds are no different from any other equity mutual fund. If one sells their investments within one year, the gains are classified as Short Term Capital Gain (STCG) and 20 percent tax is payable. Whereas, for any multi cap investment held for more than one year, the gains are classified as Long Term Capital Gain (LTCG). Such gains of up to Rs.1.25 lakh in a financial year are tax free. Beyond that threshold, LTCG is taxed at the rate of 12.5 percent.
The primary feature and advantage of investing in multi cap funds is diversification. Multi cap funds and Flexi cap funds are two variants of an equity fund that invest across market capitalizations. Of the two, multi-cap is perceived (not necessarily rightly) to be relatively safer as the market cap segregation is already provided by SEBI, while, in a flexi-cap fund the fund manager has the freedom to invest in any proportion across different market capitalizations.
More importantly, while investing in mutual funds, investors must not only focus on increasing returns but also on reducing risks which are inherent in any investment where the underlying asset class is Equity.
(Ashok Kumar heads LKW India. The views expressed here are his own)