Limitations on Multi-Cap Fund Investment

Every equity mutual fund is unique, has a unique investment objective, asset allocation, and a portfolio with the potential to generate returns over the long term. Equity mutual funds predominantly invest in equity and equity related instruments. Of its total assets, equity funds invest anywhere between 65% to 80% in stocks of publicly listed companies. That’s the minimum exposure which equity mutual funds must have to the stocks as per SEBI’s mandate.

A couple of years ago Securities and Exchange Board of India brought in some restrictions on multi-cap funds which all the Asset Management Companies had to comply with. We’ll get to that but first let us understand what multi-cap funds are.

What is a multi-cap fund?

A multi cap fund is an open ended equity scheme that must have a minimum of 25% exposure to each of the mid cap, small cap, and large cap company stocks. The term ‘cap’ stands for capitalization. When talking about multi-cap funds, it is essential to understand market capitalization.

The term ‘market capitalization’ refers to the total value of the company based on its current share price and the total number of outstanding stocks.

Companies with a large market capitalization (Top 100)are referred to as large caps. Similarly, companies with medium (Top 101 to 250) and small (250 and beyond) market capitalization are referred to as mid caps and small caps respectively.

A multi-cap fund must have equal exposure, at least a minimum of 25% in each of these market caps.

What are the restrictions imposed by SEBI on multi-cap funds?

Before the new rules were implemented, multi-cap funds had no restrictions. They were supposed to have a minimum of 65% exposure to the equity markets. However, as per the new SEBI regulations, every multi-cap fund must now invest at least 25% in each large cap, mid cap, and small cap company stock. That means the portfolio of a multi-cap fund will be structured in such a way that it will have invested 25% each in large cap, mid cap, and small cap stocks. As compared to the previous portfolio, the multi-cap funds now have a minimum exposure of 10% more as the 25% multiplied by 3 equals 75% exposure as opposed to earlier which was 65% minimum.

The reason for SEBI to bring in this change is because, at the time, most multi-cap funds had maximum exposure to the large cap market. This was defying the whole purpose of a multi-cap fund as most funds had a portfolio similar to large cap fund or a bluechip fund as some AMCs call their large cap schemes. After imposing these restrictions, SEBI also launched a few categories in the equity schemes section, ‘flexi cap’ fund. Here, the fund manager had the leeway to shift its portfolio from one market cap to another as there were no minimum exposure implications to either of the market cap. A flexi cap fund must have minimum of 65% exposure to equities with no mandate of having a specific exposure to either of the market caps.

Should I invest in multi-cap or flexi-cap funds?

Both multi-cap fund flexi cap funds have their own merits and demerits. A minimum exposure of 50% to large and mid-caps can be good when the markets are witnessing a bullish run. Whereas, if a specific market cap turns volatile, the flexi-cap fund manager can redeem all its investments and shift to a more lucrative market cap.

Investors must consult their financial advisor, discuss their goals and financial needs and only then, take an informed investment decision.

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