Multi-cap funds enjoy flexibility & freedom but a lot rides on the manager's abilities…
07-Apr-2011 •Research Desk
Unlike large-, mid- or small-cap funds that are subject to restrictions regarding where they can invest, multi-cap funds face no limitations regarding the market capitalisation of stocks they can invest in. Their mandate is to buy stocks across the entire market-cap spectrum in order to generate alpha. Managers of multi-cap funds are also allowed to invest in both value and growth stocks in their quest for beating their benchmark or category average. Theoretically, multi-cap funds are meant to weather all kinds of market conditions and come up winners. Many of them actually do.
Value Research's fund classification defines multi-cap funds as those that have allocated between 40-60 per cent of their assets to large-cap companies over the last three years.
In a multi-cap fund the fund manager is pro-active, changing and realigning his allocations to different market caps whenever market conditions change.
Flexibility and freedom are the key advantages of multi-cap funds: the fund manager can go anywhere in search of value or growth. The current market conditions, where stock prices have corrected across market capitalisations, are particularly well suited for such a fund. The fund manager can take advantage of opportunities available across the market-cap spectrum.
In the early stages of a bull run, usually large-cap stocks tend to do well. But as the bull run continues and large caps reach high valuations, investors shift their focus to mid- and small-cap stocks. It is then the turn of the latter to play catch up. Often, by the time a bull run peaks, mid- and small-caps have outperformed their large-cap counterparts. Similarly, in a bear market, mid- and small-cap stocks tend to correct much more sharply than large caps.
A good multi-cap fund manager is able to realign his portfolio rapidly and thus benefit from changing market conditions.
As is clear from the above, a lot rides on the fund manager's abilities. If the fund manager fails to read market conditions well (even veteran fund managers fail to do this consistently) and doesn't alter the complexion of his portfolio rapidly, his returns would lag. His fund would fall behind the category average in a bull market while declining more in a bear market.
The multi-cap fund manager must also be able to manage his sectoral allocations well. Sectors too go in and out of favour frequently depending on which part of the economic and market cycle one is in.
Since fund managers of multi-cap funds also tend to churn their portfolios more, their expense ratios can rise. Over the long-term this can affect the returns from the fund.
For all these reasons, multi-cap funds are more high-risk, high-return holdings than, say, a pure large-cap fund. Before investing in them, look up the fund manager's track record carefully both in up- and down-cycles.
Both aggressive and conservative investors can hold multi-cap funds in their portfolios. However, their position and role would differ. While these funds can be part of an aggressive investor's core portfolio, they should be part of a conservative investor's satellite portfolio.
Notable characteristics of multi-cap funds
• Multi-cap funds are those that have had between 40 to 60 per cent of their assets in large-cap companies over the last three years.
• These funds offer investors exposure to large-, mid- and small-cap stocks in a single portfolio.
• These funds have the latitude to find attractive stocks without market-cap, sector or style constraints.
• The investment process may involve high portfolio turnover. This could raise costs and hurt the fund’s performance.
• These funds can also have more volatility and risk.
• These are higher-risk funds that should complement the core portfolio (comprising large- or large- and mid-cap funds) of a conservative investor. They should have only a limited allocation to these funds in their satellite portfolio.