The second fund most long-term investors should have

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The second fund most long-term investors should have Aditya Roy/AI-Generated Image

Summary: You’ve probably heard of flexi-cap funds. But there’s another fund type that’s rapidly gaining investor favour… and for good reason. It’s young, bold, and surprisingly structured. And if you’re building a long-term portfolio, this could be your second essential building block. So, let’s find out the name of this fund category.

Last month, my colleague Pranit explained why flexi-cap funds deserve a permanent spot in your portfolio. He called them "adaptive", and rightly so. These funds have the freedom to shift between large-, mid- and small-cap stocks, making them a go-to choice for investors who want professional fund managers to steer the ship depending on where the wind’s blowing.

But today, we’re going to talk about another set of funds that are flexible in their own right, though with a different set of rules — multi-cap funds.

Multi-cap funds were on the verge of irrelevancy at one point

Let’s rewind to 2020. SEBI introduced a new rule for multi-cap funds: they now had to invest at least 25 per cent each in large-, mid- and small-cap stocks. At the time, many believed this would kill the category. After all, why invest in a multi-cap fund when flexi-cap funds could go anywhere?

But instead of dying out, actively-managed multi-cap funds have come into their own. Their total assets under management has grown to a healthy Rs 2.04 lakh crore, as of June 30, 2025, not bad for the new kid on the block.

How different are multi-cap funds from flexi-cap funds?

Flexi-cap funds and multi-cap funds invest in the same universe — large-, mid- and small-cap stocks. But how they do it is what sets them apart.

Flexi-cap funds have no allocation mandates. They can invest everywhere.
Multi-cap funds, on the other hand, are bound by SEBI’s rulebook. They must hold at least 25 per cent each in large, mid, and small caps. The remaining 25 per cent allocation is as per the fund managers’ discretion.

This seemingly rigid structure actually works in investors’ favour. Let’s find out why.

Why are multi-cap funds worth a closer look?

1. Stronger recent performance

In the last three years, multi-cap funds have delivered annualised returns of 19.63 per cent, compared to 16.33 per cent for flexi-cap funds.

That’s perhaps because flexi-cap funds are tilted towards large caps (around 65-70 per cent allocation), while multi-cap funds are forced to have at least half their money in mid and small caps. Thanks to the strong three-year rally in these segments, multi-cap funds have outperformed.

2. Structured exposure to mid and small caps

Instead of going all-in on a mid-cap or small-cap fund (which can be risky), multi-cap funds offer balanced exposure to these high-growth segments. You get the upside of mid and small caps, but with a cushion of large-cap stability.

And here’s a hidden advantage: built-in rebalancing. Since the fund must maintain its 25/25/25 structure, it will automatically trim outperformers and top up underperformers, leading to tax-efficient profit booking and smoother allocation.

3. Better liquidity management

Mid- and small-cap funds can struggle with liquidity, especially when they become too large. But multi-cap funds, thanks to their limited 25 per cent exposure to these segments, have a lesser problem. This gives fund managers more room to operate, even in turbulent markets.

Who should invest in a multi-cap fund?

If you have a long-term investment horizon (at least 5 to 7 years)
If you are comfortable with volatility. Their average standard deviation is 13.84, slightly higher than flexi-cap funds’ 13.39, which means the annual returns of the fund tend to fluctuate by 13.84 percentage points from the average return.
If you want diversified exposure across market caps, without having to pick separate funds

In short, this could be your second core fund, right after a flexi-cap fund.