Flexi-Cap Funds Are Trending Again — Smart Move or Herd Mentality?

Flexi-cap funds are trending again in the Indian mutual fund market. After many months of investors flowing into Mid and Small-Cap Funds, it seems that money is beginning to flow again into Flexi-Cap Funds. This rise in Flexi-Cap Funds is prompting the retail investor to ask the question, Is it a smart long-term investment or is it crowd chasing?

To accurately answer this question, we need to go deeper than just scratching the surface valuations of the Flexi-Cap Funds and analyse the current scenario and demand of these funds and if they even justify being a part of your portfolio. Our analysis will give you clarity and will strip away any emotional investment in this fund's potential.

Flexi-Cap Funds

One type of equity mutual fund is the Flexi-Cap Funds, which is a type of equity mutual fund that gives investors the liberty to invest in any and every market capitalisation. Large-Cap Funds and Mid-Cap Funds are constrained by certain rules in fund allocations, and thus Flexi-Cap Funds are able to allocate resources more freely between large, mid, and small-cap funds based on the current market scenario.

In accordance with regulations, flexi-cap funds must invest at least 65% of their asset holdings in equities, but the percentage can be flexible across different market-cap categories (i.e. large, mid, and small-caps). This operational flexibility is the competitive advantage of flexi-cap funds.

Flexi-cap funds empower professional fund managers to strategically shift exposure based on the overall market cycle and mid/small-cap opportunities. If large-cap equities are presenting opportunities, fund managers can flex the exposure to large-caps. Conversely, in an era of mid/small-cap opportunities, the exposure can be flexed to mid/small caps.

 

 

Why Flexi-Cap Funds Are Trending Again

There are legitimate market-driven reasons behind the unprecedented growth in flexi-cap funds.

First, after a prolonged rally in mid-caps, fund managers and aggressive investors began to shift their attention to small-cap equities. Although in the absence of flexi-cap funds, mid/small caps would typically experience irrational and unfounded price collapses.

Second, the market has been highly volatile in the last couple of years. During highly volatile times, investors like to put their money into funds with flexible allocations. Flexi-cap funds are popular as mid/small-cap funds.

Third, the more recent regulations have shed light on definitional categories. There is now more clarity for investors on the differences between multi-cap and flexi-cap funds. Because flexi-cap funds have no such requirement, they are perceived as more manager-driven and more adjustable to risk because they do not have to hold mandatory exposures across all market caps.

Finally, long-term investors understand that it does not pay to chase last year’s top-performing categories. This change in thinking has brought attention back to diversified equity mutual funds like flexi-cap funds, which seek to deliver consistent performance rather than short-term jumps.

Flexi-Cap Funds vs Other Equity Mutual Funds

In the comparison of flexi-cap funds to other equity mutual funds, the differences stem from the aspects of control and adaptiveness.

Large-cap funds are more stable, but they can underperform in bullish phases that are led by mid and small-cap stocks. Mid-cap and small-cap funds can offer more substantial returns, but they also carry much more volatility and have larger potential drawdowns. Multi-cap funds are bound by regulations to have a certain minimum exposure across all market cap segments, which can sometimes lead to mandatory exposures, even if the valuations are not favourable.

Flexi-cap funds walk a fine line. They have the long-term stability of large-cap funds while also having the growth potential of mid-cap and small-cap funds. However, fund managers can make different allocations as they please. This is why they are suitable for investors looking for equity exposure, while wanting a smoother overall performance.

How Flexi-Cap Fund Managers Create Value

One of the most important factors in the performance of a fund is the fund manager. A good manager can adjust a fund's exposure to the market by utilising a certain market cycle. This is the case for a good flexi-cap fund manager. The investments they make are not based on a passively assigned allocation system.

Good managers are active in the markets and are constantly evaluating a company's growth and checking balance sheet strength, among other factors. When markets are expensive and are in a bubble, good managers will hold mid and small-cap stocks and will buy large-cap stocks.

Flexi-cap funds can adjust their parameters, unlike small-mid cap funds, which allows them to balance their risk and reward.

Are Flexi-Cap Funds Just Herd Mentality?

With the growing popularity of flexi-cap funds, one might wonder if this is a case of bubble behaviour or just flexi-cap funds being popular for 'liking' them. This, of course, depends on the perspective of the investors.

Some say that social media trends and recent fund inflows should not dictate investor movements, and that a herd mentality is created if investors shift to flexi-cap funds. To the contrary, investors do not balance risk, reduce volatility, and come up with sensible long-term equity strategies if flexi-cap funds are not a rational choice.

Thematic and sector funds that become popular around the peaks of a market cycle, flexi-cap funds are not like other products. Their growing popularity is indicative of a more mature investor base.

Performance of flexi-cap funds across different phases of the market

In the past, flexi-cap funds have performed well during different phases of the markets and the long-term returns have been rewarding, and they have drawn fewer corrections compared to the more aggressive equity categories. Merely lagging behind the more aggressive mid-cap funds during a bull market, they have also corrected better and, hence, protected the capital.

With their balance over the different phases of the market, they have also delivered better returns for the risk taken for the investors who are looking to create wealth over the long term.

Who Should Invest in Flexi-Cap Funds

Long-term equity investors and investors who have active equity SIPs will be able to benefit from flexi-cap funds since these funds do not require the investors to actively time the market and reduce the stress associated with market volatility. These funds are also appropriate for investors who are nearing key milestones in their financial planning, since they may not have the luxury to experience extended periods of extreme market volatility.

Flexi-cap funds are also beneficial for those investors who dislike frequent manual rebalancing of their investments across different market capitalisations. Your fund manager will do that for you.

 

 

Who Should Avoid Flexi-Cap Funds

When it comes to flexi-cap funds, not everyone will find these funds suitable. Investors with an appetite for significantly high risks will perhaps find flexi-cap funds to be on the conservative side and may be on the lookout for more aggressively managed mid and small-cap funds.

A mid-cap flexi-cap fund can also be more suitable for investors who may appreciate the volatility of the fund but do not have the buffer to withstand the changes that come with the flexi-cap fund. If you are going to invest in a flexi-cap fund, understanding your risk appetite will be an important factor to consider.

Best Flexi-Cap Mutual Funds: What to Look For

Rather than pursuing the best flexi-cap mutual funds and chasing short-term returns, investors would be better off focusing on a consistent portfolio and an experienced fund manager.

(A flexi-cap fund) is quite a mixed bag and the best flexi-cap funds will have both a disciplined process and strong downside protection, balanced with reasonable turnover and a diversified portfolio. When examining a flexi-cap fund, expense ratio, portfolio concentration, and rolling returns over a long period of time far outweigh the fund's performance over a single year.

Investment Horizon and Taxation

Like all equity funds, flexi-cap funds have the same treatment. If a fund is held for over a year, the investor must pay long-term capital gains tax. If the investor redeems (withdraws) the fund before a year is over, then the investor must pay short-term capital gains tax.

Because of the nature of a flexi-cap fund, the optimal time to hold on to a flexi-cap fund is five to seven years. That period of time will give enough time for the fund manager's strategy to be carried out and the fund to be adjusted to the varying levels of market volatility.

 

 

Conclusion

Flexi-cap funds going back into style is a sign of the times. It is indicative of a more balanced and professionally managed investment. And quite the contrary to a bubble, it is showing evidence of real demand. For long-term investors, flexi-cap funds provide an opportunity to create real, sustainable wealth. Not for shimmering short-term gains, flexi-cap funds take the portfolio risk of staying invested through the market cycles.

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.