Multi-Cap Funds vs Large-Cap, Mid-Cap and Small-Cap Funds
Multi-Cap funds invest across categories of equity like large-cap, mid-cap and small-cap and that too in a proportion which the fund manager feels suitable. However, what if you create a portfolio of large-cap, mid-cap and small-cap funds? DSIJ studies and explains what should be your approach, i.e., whether to go for multi-cap funds or create a personalised portfolio of large-cap, mid-cap and small-cap funds.
Last one-and-half year has not been very kind to mutual fund investors. First we saw equity investors losing their money due to correction in the equity markets in year 2018 after the reintroduction of long term capital gain tax. Once the market was coming out of this turmoil, it was hit by the debt market crisis, which led to losses to investors in their debt portfolios. We are still not out of woods; however, there are some pockets of opportunities emerging. One of these is the multi-cap funds, which have outperformed other categories in the last three months ending June 2019. On an average these funds have performed better than any other equity category of mutual funds, except for sectoral funds. This outperformance has also attracted higher monthly inflows into this category. According to the data published by industry body, Association of Mutual Funds in India, in the last two months, the net inflow in multi-cap funds has been to the tune of `2521 crore, higher than any other equity category such as large-cap, small-cap and mid-cap during the same period. So, is it the right time to invest in multi-cap funds and are they going to outperform other categories? Before that, let us understand what are multi-cap funds.
Multi-cap funds
According to the SEBI’s circular, a multi-cap fund is a fund which can invest across market caps while having a minimum of 65 per cent of total assets in equity and equity-related instruments. This means that they can invest not only in large-cap stocks, but also mid-cap and small-cap stocks and that too in any proportion the fund manager may deem fit. Hence, if a fund manager believes that large-cap stocks are going to generate better returns, he can change the constituents of his portfolio accordingly. A study of the current portfolio constituents of multi-cap funds shows that larger weightage is given to large-cap stocks which, in general, have performed better in the last one year or so. The fund manager can also invest a maximum of up to 35% in debt, if he believes that equities are volatile now and debt is the right place to be in.
Now the question arises as to why one should invest in multi-cap funds when they can invest in a portfolio of largecaps, mid-cap and small-cap funds and can tweak the proportions based on the individual risk and requirements? When you invest in a multi-cap fund, the fund manager, who is an expert professional having good amount of experience and knowledge about the markets, can take a call and act upon it without any delay. However, when you manage a portfolio yourself, you need to have appropriate knowledge and experience and, on top of that, the time to manage your portfolio yourself. However, this again opens the question as to how multi-cap funds fare when it comes to the portfolio of large-cap, mid-cap and small-cap funds. Is it worth getting your hands dirty and manage the portfolio yourself?
The study
To understand it and get a better insight, we need to know how these categories (multi-cap, large-cap, mid-cap and small-cap) have performed compared to each other during different time frames. Besides, we have also taken equity bellwether index, Sensex, to understand the return pattern of funds. While studying the performance, we have considered 1-year, 3-year and 5-year annualised rolling returns for the period from June 11, 2008 to June 19, 2019. It is to be noted that the rolling returns have been calculated on the daily NAVs for the period and an average of the same is taken.
The following table shows the average returns generated by different categories of funds over different time periods.
If we look at the above table and graph, we see that among the different categories, mid-cap funds have consistently outperformed other fund categories over all time frames. It is followed by the small-cap funds and equal-weighted portfolio of large-cap, mid-cap and small-cap funds. The frontline index Sensex, however, has performed poorly as compared with the other categories. These numbers are average and hence, to get a better understanding of the returns, we dived deep to understand how these categories fair in different market scenarios.
We studied a total of 2740 instances. If we look at the performance of different categories of funds in a falling market, then clearly Sensex has given best returns or has fallen lesser than other categories of funds. It is followed by large-cap funds and multi-cap funds. But the mid-cap and small-cap funds clearly fail to withstand the shocks of the falling market.
When it comes to three-year average rolling returns, then also the picture does not change much and remains the same as 1-year average rolling returns. Here too while the market rises, the mid-cap and small-cap funds perform well, whereas Sensex performs poorly when compared to other categories. But when the market falls, the Sensex is able to hold the downfall better than others, followed by large-cap funds and multi-cap funds. The mid-cap and small-cap funds lose in the falling market when compared to other categories. We studied 1,972 instances in this case.
The funds on an average have never generated negative returns during the five-year rolling returns in any time frame that we studied. Here, we studied 1,480 instances. The 5-year average rolling returns give us a better idea as to how the different categories are performing on a long-term basis. The graph above clearly shows that with a long-term perspective, mid-cap and small-cap funds clearly win, followed by multi-cap funds. In the long-term, the Sensex clearly underperforms other categories.
The above observation may suggest investing in mid-cap and small-cap funds as these are the best way to earn better returns in the longer run. However, in the above analysis, we have not taken any risk factors into consideration. Your ability to contain risk matters when you invest. You should take only those risks that you can digest. For this, you need to assess your risk profile.
Portfolio of Large Cap, Mid Cap and Small Cap Funds Vs Multi-cap Funds
Now we will check our original proposition whether you should invest directly in a multi-cap fund or make a portfolio of smallcap, mid-cap and large-cap funds and manage it. To illustrate this, we constructed an equally weighted portfolio of large-cap, mid-cap and small-cap funds and compared it with multi-cap funds. Once again, we divided our analysis into three time frames, that is, one-year, three-year and five-year. For every period, we took rolling returns of the funds.
Investing For One Year
If we look at the 1-year rolling returns of the equally weighted portfolio and the multi-cap funds, then we can see that the portfolio performs better than Sensex and multi-cap funds when the market is rising, while during downturn, it underperforms most of the times. One of the reasons for such performance is that the mid-cap and small-cap funds form two-third of the portfolio, which move faster than the frontline indices. Hence, when the markets goes up, these funds go up faster and when the market goes down, they drop at faster pace.
To get a deeper understanding, we segregated the study in terms of number of times multi-cap funds have outperformed the portfolio or the Sensex.
In the one-year period, the multi-cap funds have largely underperformed the portfolio, while these funds have outperformed the Sensex. Of all the observations of 1-year rolling returns in 1,640 out of 2,470 instances, the multi-cap funds have underperformed the portfolio, whereas only in 830 instances it has turned out to be positive. It is completely opposite in the case of Sensex, with multi-cap funds beating the Sensex in 1,621 instances, while underperforming in 849 cases.
Investing for 3-year period
When it comes to three-year period, we see the performance gap widening in the 3-year rolling returns, especially post Oct 2011, when the mid-cap and small-cap stocks were a rage and were favourites with the investing fraternity. This is the reason when the markets were rising and the portfolio increased at a good pace and beat the performance of multi-cap funds and the Sensex. However, when the markets fell in the last one-and-half year, the portfolio fell more as compared to multi-cap funds and Sensex.
Investing for 5-year period
When it comes to the long-term perspective, 5-year rolling returns give a better picture. If we look at the above graph, we can say that over the long-term, equally weighted portfolio performs way better than the multi-cap fund and Sensex. This shows that holding an equal weighted portfolio of large-cap, mid-cap and small-cap funds proves to be a better option than investing in multi-cap funds.
In the case of 5-year rolling returns, the equally weighted portfolio of large-cap, mid-cap and small-cap was able to beat the performance of multi-cap funds in more than 90% of the instances. It outperformed the multi-cap funds 1381 times out of a total 1,480 instances, which makes the portfolio a clear winner. However, multi-cap funds were able to outperform Sensex in all instances.
The portfolio of large-cap, mid-cap and small-cap seems to be doing better than that of multi-cap funds and the Sensex. Needless to say that the multi-cap funds, portfolio and Sensex did not have any negative observations in the 5-year rolling returns.
Looking at 5-Year average rolling returns, Multi cap, portfolio of Large cap, Mid cap and Small cap and Sensex gave no negative returns.
Conclusion
So, looking at the above analysis, should you go for constructing your own multi-cap fund portfolio by investing equally in large-cap, mid-cap and small-cap funds? From the above study, we can clearly see that a portfolio of large-cap, mid-cap and small-cap funds performs much better than a multi-cap fund during most of the period. If we take the consolidated view (one-year, three-year and five-year time frames) three-fourth of the times, the portfolio of large-cap, mid-cap and small-cap has beaten the performance of multicap fund and it increases as the length of investment goes up. However, it is to be understood that in our study, we have taken the average results of the mutual funds of respective categories, which involve good, moderate as well as bad performers. So, if you can identify good multi-cap funds, you can continue with your choice of investment. Nevertheless, if you are not sure--and most of us are not--you can definitely go and make your own portfolio.
Besides, we have analysed the scenarios with returns as the only criterion. However, while investing, return is not the only criterion as the risk-taking ability of the investor matters equally. In our study, we have considered an equal weighted portfolio, but you may have different risk-taking ability. Conservative investors should be low on mid-cap and smallcap funds, whereas aggressive investors should be high on mid-cap and small-cap funds taking into consideration a long-term investment approach. Hence, having your own unique financial plan is important as it will not just provide you the broader guideline about your investment portfolio but also help you to streamline all your personal finances.