Investors have always been attracted towards multicap mutual funds due to their flexibility of investing in large-cap, mid-cap and small-cap companies. Fund managers balance the asset allocations as per the market conditions to get maximum returns. But earlier, because of flexibility, investors were unable to understand the risk associated with it.
To address this issue, SEBI (Securities and Exchange Board of India) stepped in and set new rules and guidelines for multi-cap funds. These regulations were aimed at improving transparency, diversification, and risk balance.
What Are Multi-Cap Funds?
Multi-cap funds are equity mutual funds that invest across companies of different capitalisations, like large-cap, mid-cap and small-cap companies. The idea behind it is diversification. Instead of putting your money in different mutual funds, multi-cap funds provide a similar impact with a single investment.
This gives the investors a balanced equity allocation, which gives stability through large-cap companies, growth through mid-cap and higher returns through small-cap companies. This makes a perfect recipe for a long-term investor.
Why SEBI Introduced New Rules for Multi-Cap Funds
Earlier, multi cap funds had complete freedom over allocation. Hence, many funds tilted heavily toward large-cap stocks to reduce volatility, even though they were marketed as diversified equity funds. This created a mismatch between investor expectations and actual returns.
SEBI stepped in to bring consistency, clarity, and discipline to the multi-cap funds.
SEBI has brought structural clarity to the multi-cap fund category. These rules were designed to reduce concentration risk, improve transparency, and align fund behaviour more closely with investor expectations.
Mandatory Market-Cap Allocation
SEBI mandated the fund manager to allocate at least 25% in each category: large-cap, mid-cap and small-cap. The remaining 25% can be allocated as per the fund manager’s analysis. This ensures diversification in each category and reduces exposure to a single category.
Portfolio Rebalancing
Fund managers may need to rebalance their earlier portfolios of multi-cap funds to align with the minimum equity allocation criteria. This could lead to selling prior assets and buying new ones.
Reduced Fund Manager Discretion
Due to mandatory cap allocation, fund managers can no longer expose the majority of capital to any single market segment. Even though they have some flexibility for fund allocation, investors can still get balanced returns.
Improved Transparency and Classification
SEBI’s new rules improve transparency and make fund comparisons easier for investors. Mis-selling risks are also reduced because of the fund’s mandate. Investors can now select funds based on clearly defined risk profiles instead of marketing labels.
Investors Action
Here are some of the pointers that investors should consider.
- Investors should review their existing multi-cap fund holdings. Funds launched before the rule change may have adjusted their portfolios and risk levels.
- Investors must align multi-cap funds with their time horizon. Since these funds now carry mandatory small-cap exposure, they are best suited for long-term goals.
- It is important to compare multi-cap funds only within the same category. Comparing them with flexi-cap or large-cap funds can lead to incorrect conclusions due to different risk structures.
What Risks Still Remain in Multi-Cap Funds?
Multi-cap funds are still equity-oriented and vulnerable to market risk despite their improved structure. However, they have lower risk compared to some of the best small cap mutual funds due to diversified allocation. During market corrections, the required small-cap allocation may make things more volatile. There may be short-term drawdowns, particularly in uncertain economic times.
These funds are not suitable for short-term goals or investors with low risk tolerance. A long investment horizon is essential to benefit from diversification across market cycles.
Conclusion
SEBI’s new rules have increased transparency and have given a truly balanced investment option. These rules act as a safety net by enforcing diversification and reducing extreme fund behaviour. Still, investors should understand the risks associated and their risk appetite before making any investment.