Value Research exclusive: First-ever multi-cap fund ratings revealed

Judgement day is finally here for multi-cap funds . It is time for us at Value Research to bring out our green and red markers to rate them. Since 10 multi-cap funds recently completed their third anniversary, we thought it was apt to run a rule over them and hand out our much-awaited Value Research Ratings.

Inaugural multi-cap fund ratings

Nippon India Multi Cap Fund is the class topper in our maiden list, with a flawless five-star rating, while Quant Active scrapes the barrel at the other end of the table.

Here's our rating for each of the 10 multi-cap funds that have completed their third year of existence.

Quick history of multi-cap funds

Let's rewind to 2020. The capital markets regulator SEBI (Securities and Exchange Board of India) introduced 'forced mandates' for multi-cap funds.

Many people thought this would doom multi-cap funds. Because when multi-cap funds were introduced, the idea of having two categories—flexi-cap and multi-cap—seemed redundant. Flexi-cap funds could invest freely across market caps, whereas multi-cap funds had to follow defined allocation limits (invest at least 25 per cent each in large, mid, and small caps). Initially, this distinction felt arbitrary and misaligned with investor interests.

Fast forward to today, multi-cap funds have proven their mettle, albeit they are still in their infancy. With an asset base of Rs 1.75 lakh crore (compared to Rs 5.97 lakh crore for flexi-caps), multi-cap funds have shown impressive growth despite being a newer category. Notably, the number of multi-cap funds has grown from just eight at the start of 2021 to 33 today, reflecting their rising popularity among investors and fund houses alike.

What's worked for multi-cap funds?

1. Performance, especially compared to flexi-cap funds

Multi-cap funds have grown at an annual rate of 17.8 per cent in the last three years, against flexi-cap funds' 14.1 per cent.

Why? Flexi-cap funds often lean heavily on large caps, with an average 75 per cent allocation. On the other hand, since multi-cap funds need to have at least 50 per cent exposure in mid and small caps, the recent rally in those segments has given multi-cap funds a huge boost.

2. Structured asset allocation

SEBI's 'forced mandate' has worked in multi-cap funds' favour. Since multi-cap funds are bound to have a minimum 50 per cent of investor money in mid and small caps, they can be an attractive choice for long-term investors seeking more exposure to these two segments.

Furthermore, the mandated allocation ensures timely rebalancing of multi-cap fund portfolios, making it tax-efficient.

3. Lack of liquidity constraints

Another reason the forced mandate is a blessing for multi-cap funds is their built-in liquidity buffer. By allocating only 25 per cent to mid and small caps, they avoid liquidity constraints that can arise in mid and small-cap funds as they need to invest a minimum of 65 per cent in their respective segments. As such, even the largest multicap funds have ample room to grow before liquidity becomes a concern.

Our take

Even though multi-cap funds have delivered superior returns since launch, it's too early to say whether it will continue. They have only existed in a cheerful market.

Since mid and small caps historically witness steeper falls than large caps during market downturns, their performance in bearish phases remains to be seen.

So, invest in multi-cap funds only if:

• You have a long-term investment horizon of at least 5 or 7 years
  
• You have a high-risk appetite to absorb the ups and downs associated with mid and small caps

Looking for fund-specific recommendations? You can find them here.

Also read: Flexi-cap fund vs multi-cap fund: Which is better?