When you put your money in an equity mutual fund, do you also tell the fund manager which stocks to buy? No, and yes. While investors don't give any instructions, a fund with a fixed investment mandate picks only those type of stocks.
For instance, a large-cap fund will invest only in index-based heavyweights and other blue chips. You won't find a small-cap company in its portfolio. This is why large-cap funds tend to move slowly and surely compared with other categories. Similarly, a small-cap fund will focus on smaller companies, forever hoping to zero in on the next Infosys that will turn it into a multibagger.
On the other hand, multi-cap funds invest across the entire spectrum of stocks, starting from large-caps all the way down to small-caps. They have a flexible mandate, which helps them pick winners from across market capitalisations.
"Wealth creation happens when the fund management process has flexibility. Multi-cap funds have an in-built mandate to capture the upside across the market spectrum," says Om Ahuja, head of private wealth management and strategy at Emkay Global Financial Services .
The performance of multi-cap diversified equity funds bears this out. In the past three and five years, this category has given higher returns than those from other categories of diversified funds (see table). As companies belonging to different market segments demonstrate different levels of volatility and returns, it is best for investors to hold stocks of varying market capitalisations.
"Multi-cap funds provide the investors with the offer to build a diversified portfolio by giving them access to all kinds of equities," says KN Sivasubramanian, chief investment officer, Franklin Templeton Investments .
For instance, in the past one year, mid- and small-cap funds have done exceedingly well, but in the long-term, multi-cap funds have consistently outperformed the other categories. "Multi-cap funds are the best investment option for creating wealth in the long term," points out Ahuja.
Work in all market conditions
The flexible mandate of multi-cap funds gives them access to greener pastures in all market conditions. At the beginning of a bullish phase, it is usually the large-cap bellwether stocks that do well. Midway through the bull run, these large-cap stocks reach high valuations and the focus of the investing community shifts to mid-cap and then finally small-cap stocks.
"Retail investors cannot gauge which part of the market will perform well-large-caps, mid-cap or small caps. By investing in multi-cap funds, they can gain in all market conditions," says Saurabh Jain, associate vice-president, retail equities research, SMC Global Securities .
The 'go anywhere' strategy works well during downturns as well. "While a given set of conditions may not benefit one part of the multi-cap fund portfolio, it could benefit the other, thereby creating a counter-balance effect that generates long-term results," says Maneesh Kumar, managing director, Burgeon Wealth Advisors. When the bears are on the prowl, small-cap and mid-cap stocks fall harder than large-caps. Multi-cap funds are able to cushion themselves better than funds which are focused only on these vulnerable segments.
A deft fund manager can realign the fund's portfolio rapidly and thus benefit from the changing market mood. "Besides, in a black swan kind of a scenario, such as the financial crisis that we experienced in 2008, a multi-cap fund will be able to bear redemption pressures better compared with a mid- and small-cap fund as it is likely to be more liquid," adds Kumar.
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