Why do you invest through mutual funds? Why not in stocks? Of course, many of you would also be investing in stocks but since you are reading this page, I assume that you invest primarily in mutual funds.
For most people, the answer would be that stock research and investing is just too consuming and too complex to learn and execute. However, investing in equity mutual funds also suffers from a surfeit of funds and choices. Even ignoring different plans of individual funds, there are 1,574 equity funds that are available to the Indian investor. These come in a bewildering array of 37 categories. As I've pointed out often, these numbers are entirely the result of the marketing imperatives of mutual fund companies. If the goal were to serve investors well, then no AMC would cross about eight to 12 funds and we would have about 400 mutual funds in all. It goes without saying that if this were the case, then a much greater proportion of funds would be well-managed and it would be much easier to pick a good one.
A casual glance at this set indicates that before choosing even a set of funds suitable for your needs, you have to wade into all kinds of details about company sizes (large-cap, mid-cap, small-cap, etc.), sectors, themes, Indian equity, foreign equities and much else.
For a moment, let us consider the basic deal that a mutual fund is supposed to offer you: pay a fee and hire a fund-management team. If you take this idea logically, then you should not have to make any of your decisions yourself. It's not your job to figure out whether, at this point of time, large caps are better or mid caps are better or you should be invested in this sector or that. This is exactly what you are paying for.
This is what multi-cap funds were supposed to do. And for a long time, they did. However, then the story got complicated. SEBI took a dislike to the way some multi-cap funds were being run and changed some rules, and now there are almost no multi-cap funds but what used to be multi-cap funds are now called flexi-cap funds and the net result is that it's a lot more complicated for most investors to figure out which of the two (if any) are suitable for the original idea of multi caps, which was that you, the investor, did not have to bother about all this.
The rule change was that from January 2021 onwards, such funds should have at least 25 per cent of their assets in large-, mid- and small-cap stocks and this is to be done so that these funds would be 'true to label'. Principally, this is a problem. Even a cursory examination of SEBI's own definition of large, mid and small cap shows that the 25 per cent limits will lead to a drastic over-representation of mid- and small-cap companies in multi-cap funds.
The mid- and small-cap percentages specified were much higher than what multi caps were actually running at. Moreover, once a fund gets large, say larger than about Rs 15,000-20,000 crore AUM, then it's impossible to have a high proportion of small caps or even the smaller mid caps. Small caps typically have low floating stock and low volumes. They can't be bought or sold in any substantial quantities. This is not a problem that actually has a solution, regardless of what the rules say.
So, now we have a situation where there are multi-cap funds, which must have at least 25 per cent in each cap range and at least 75 per cent overall in equity. Flexi caps must have at least 65 per cent in equity and as far as SEBI is concerned, that's the end of it - the funds are genuinely 'flexi' apart from that. Investors can choose one or the other based on their understanding of what these specifications mean, which is somewhat more work than it used to be, but still doable for most.
This editorial appeared in Mutual Fund Insight February 2022 issue. To read the cover story and other insightful analyses, columns and articles
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