Mutual funds come with several benefits, however, one of the most prominent ones is the diversification they offer. Equity mutual funds invest in stocks of companies across different sectors and market capitalizations based on which they are categorized. Multicap funds are one such equity mutual fund. But to understand what these funds are, we must first understand what market capitalization means.
What is market capitalization?
Companies in the market can be categorized based on their market capitalization which is essentially their market value. This market value is based on the company’s current stock price and its total number of outstanding shares. Based on market capitalization companies are divided into three categories – small-cap, mid-cap, and large-cap.
Mutual funds too depending on the type of company they invest most of their portfolio into small-cap funds, mid-cap funds, and large-cap funds. So, for instance, a large-cap mutual fund would primarily invest in the stocks of large-cap companies – the top 100 companies on a stock exchange based on their market capitalization.
What are multicap funds?
Each of these three types of equity mutual funds – small-cap, mid-cap, and large-cap – come with its risk-return profile. For instance, since small-cap companies are typically the newer, smaller companies, they have immense growth potential. However, at the same time they are also the most volatile, and hence the risk of investing in small-cap funds is also higher. As for large-cap funds, they are more stable since they invest in stocks of companies that tend to be the industry leaders. However, the return potential of large-cap funds is not as high as that of small-cap and mid-cap funds.
Instead of having to pick a mutual fund that only really invests in companies of one market capitalization, you can simply invest in multicap mutual funds. Multicap funds invest in stocks of companies across market capitalization to bring to you a portfolio that is well-diversified, offering higher returns while the risk is hedged.
According to the guidelines of the Securities and Exchange Board of India (SEBI), multicap funds need to invest a minimum of:
- 25% in large-cap stocks
- 25% in mid-cap stocks
- 25% in small-cap stocks
Hence, multicap funds must invest a minimum of 75% of their portfolio in equities in this manner. Multicap funds used to have a large-cap bias before this SEBI regulation was introduced. That’s because earlier there was no mandated proportion to be maintained across these three categories. However, now, multicap funds are a great way to invest in stocks of companies across multiple market capitalizations and sectors through just one investment. This kind of convenience and strategic asset allocation is unique to mutual funds like multicap funds.
Is multicap fund the best mutual fund investment option?
There are several other types of equity mutual funds such as focused funds and flexi-cap funds. While focused funds can invest across all three market capitalizations, they can’t invest in more than 30 stocks. This means low diversification but also higher returns because in the case of focused funds the fund managers are even more careful in cherry-picking the 30 stocks to follow a specific investment strategy and earn certain types of returns. Flexi-cap funds are the type of equity mutual fund where the fund managers have the freedom to change the exposure to stocks of small-cap, mid-cap, and large-cap stocks depending on the market conditions as long as the overall portfolio has a 65% equity focus.
Hence, the important thing to figure out here is what your risk appetite is and what financial goals are you looking to make your mutual fund investment. That’s because each mutual fund comes with its own set of pros and cons and varying levels of risk so you can’t simply make the decision based on its features. You also need to make sure to consider your financial strategy.