Investing in mutual funds is one of the smartest decisions you can make as an investor. However, your returns can be maximized only when you pick the right type of mutual fund. While the primary categorization of mutual funds is equity, debt, and hybrid, each of these categories also has several types of mutual funds. If you are considering investing in equity funds, then look at multi-cap funds as industry data reveals that they have been one of the best-performing funds in the last year.
The major point of differentiation between multi-cap funds and other equity funds is its portfolio composition requirements. As per the regulations of the Securities and Exchange Board of India (SEBI), multi-cap mutual funds need to invest a minimum of 75% in stocks in the following manner:
- 25% in large-cap stocks
- 25% in mid-cap stocks
- 25% in small-cap stocks
The benefit of diversification across market capitalizations
Why is this feature of multi-cap funds – investing in small-cap, mid-cap, and large-cap stocks – so beneficial? That is because companies of different market capitalizations have different risk-return profiles.
In times of boom, small-cap stocks tend to outperform the broader market. While large-cap and mid-cap stocks also perform well, their growth potential is limited. The reason is that small-cap companies are generally young companies with a market capitalization of less than Rs 100 crore and come with significant growth potential. But the risk, too, is a lot higher with small-cap companies because not all of them will be able to survive and thrive.
In times of economic downturns, it’s the large-cap companies that remain the most stable. These companies are usually leaders in their respective industries and tend to be less volatile. As compared to small-cap stocks, mid-cap stocks too are less volatile and more stable. During recessions, small-cap stocks have seen to underperform as compared to large-cap and mid-cap stocks.
Since the economic cycles impact stocks with different market capitalizations differently, to have a portfolio that strategically includes stocks of companies across market capitalizations allows fund managers to maximize returns for you is beneficial. This is because the risk is hedged, and market opportunities are capitalized on with different portfolio holdings.
Things to consider when investing in multi-cap funds
- Your investment horizon: Like with all equity mutual funds, if you want to invest in multi-cap funds, you should have an investment horizon of at least five years. Hence, consider what your financial goals are and in what timeline do you want to meet them.
- Your risk tolerance: While multi-cap funds hedge risk by investing in stocks across market segments, they are still equity funds. Hence, you should consider what your risk appetite is like. You should also look at your current investment portfolio’s asset allocation to see how much more equity exposure do you need.
- Taxation of multi-cap funds: The profits you make on the sale of your units within 12 months are categorized as short-term capital gains and are taxed at 15%. For units you sell after 12 months, the gains on those are taxed at 10% and are considered long-term capital gains.
The bottom line
Multi-cap funds ensure that your fund portfolio is always exposed to all segments of the market and that it performs well irrespective of the market cycle. Whether it is a bullish or bearish market, your portfolio remains well-balanced with the stability of large-cap stocks and the higher returns potential of small-cap and mid-cap stocks. This is why multi-cap funds are an evergreen investment opportunity. And given the current market volatility, this kind of mutual fund is the most desirable amongst many investors. For this reason, multi-cap funds also make for a good investment option when you want exposure to mid-cap and small-cap companies without taking too much risk.