Flexi Caps- Are they Flexible enough to optimise your Returns?   May 12, 2012

Sustained broad based rallies have become a thing of past. In May 2009, market had rallied ferociously and broader indices were locked in the upper circuit when United Progressive Alliance (UPA) returned to power, getting a clear mandate from voters. However, the market has been absolutely flat and moving in a range since then. Such range bound markets frustrate investors, as generating returns becomes difficult. Retail investors often prefer to stay out of market under market conditions such as these. But one has to realise that staying invested is important to benefit from market rallies, as more often than not, they are sporadic and surprising. It is also important to understand that markets behave differently under different economic conditions. Furthermore, performance of different market capitalisation segments - be it the large caps, mid-caps or small caps, varies remarkably from one another. Investing in equities, through mutual funds, releases you from onus of buying right stocks. However, mutual funds may not always help you invest in the right market cap segment; you have to take that decision. The reason is, some mutual funds overtly hold a specific market capitalisation bias and confine their investment universe only to a particular market capitalisation segment. For a person who doesn’t actively track the markets, it becomes difficult to decide upon the market segment he should invest in, to benefit the most. We herein discuss how a particular category of mutual funds can come to rescue of such investors.

A Flexi way- Flexi Cap Funds

There is a category of diversified equity funds called flexi-cap which aims to optimise the exposure to every market capitalisation segment depending on its attractiveness. In other words, a flexi cap fund can work as a large cap fund if the fund manager expects a better performance from large caps and it may serve as a mid & small cap fund if he (the fund manager) turns bullish on mid-sized companies. Some funds go one step ahead and switch between asset classes such as debt and equity with flexibility to go 100% on either sides. We studied the performance of all such existing funds which, by mandate, are a flexi cap in order to check if they really fit in anywhere in your portfolio.

Performance of Flexi Caps

It is clear from the table below that not all market capitalisation segments have performed similarly over last 10 financial years. For example, at the beginning of the last decade, large caps underperformed broader markets and especially the mid & small caps as S&P CNX Nifty registered a tepid performance vis-à-vis the performance of BSE-500, BSE Midcap, and BSE Smallcap Index. However, flexi cap funds managed to put a better show than the S&P CNX Nifty on the upside moves, and beat BSE Midcap, BSE Small cap in the market downtrend. The Y-o-Y performance of flexi cap funds shows that the collective performance of flexi cap funds has always been comparable to that of BSE-500, the most diversified index that has the maximum market representation.

Study of performance across market cycles reveals that flexi caps have never been the top performers or the bottom performers in comparison with some major indices. During the sustained bull phase of 2005-08, the market was over heated and virtually all major diversified indices underperformed BSE-500. During this market phase, flexi cap funds not only outperformed S&P CNX Nifty but also the BSE Midcap and BSE Smallcap. On the other hand, in the horrendous bear market of 2008-09, the flexi caps remain closer to S&P CNX Nifty in the performance charts suggesting the better risk management employed by the fund managers. Likewise, although in the subsequent recovery phase they (flexi cap funds) they severely underperformed mid and small cap indices; they managed to beat the large cap index S&P CNX Nifty. Well, the main reason for such substantial underperformance against the mid and small cap indices is that, their portfolio was mainly skewed in large caps during the recovery phase. This strategy has worked well for them in the on-going corrective phase, where mid and small caps have lost more than the big boys – the large caps. The global economic recovery and the market recovery too has been a tough ride and flexi cap funds have preferred to go with large caps for now.

So far, we have broadly seen how the flexi cap funds have fared against various equity indices. Now we would shed some light on where do they stand in competition with other categories of diversified mutual funds?

Yes, the performance of flexi cap funds as a category has been ordinary as against that of other diversified equity funds. Having said that, they still have managed to outpace BSE-500 on all crucial milestones. More importantly they have been less volatile (as revealed by their lower standard deviation) and have generated on par risk adjusted returns (as expressed by the Sharpe Ratio).

Now that we know the role which flexi cap funds can play in your portfolio, it is imperative to study the performance of every constituent fund of the flexi cap category. Our findings were startling. As indicated in the table below, just half the schemes have outperformed BSE-500 on crucial milestones with an exception of performance over a 3 year time period. While the number of schemes outperforming the category average of rest diversified equity funds fell further.

We believe flexi cap funds may work as all-weather funds in your portfolio and can generate long term wealth provided you select the right one. There have been very few flexi caps that have managed to beat both, the BSE-500 and the category average of other diversified equity funds on nearly all important milestones. This exemplifies the importance of selecting a right flexi cap fund for your portfolio. There are no easy pickings, thorough research is a must.

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