Flexicap funds help balance risks, returns
Notwithstanding the fierce second wave of covid-19, Indian equity markets have continued their rally upward. Benchmark indices such as the BSE Sensex and Nifty have doubled since the nationwide lockdown imposed at the end of March 2020. Stock markets globally, too, have been on a strong footing, trading at high valuations, supported by liquidity unleashed by global central banks. Besides liquidity support, the fact that the cost of capital is close to zero in most parts of the world has played a big role in ensuring that equity markets remain resilient.
The Indian business cycle remains attractive given that corporates have deleveraged, credit growth is very low, capex cycle is yet to revive and the profit-to-GDP ratio, too, is low. Economic recovery seems to have been delayed by the second wave; but recovery is well on track, given the fairly resilient domestic economic indicators, favourable macro environment, government policies and supportive measures taken by the Reserve Bank of India.
However, US corporate-profit-to-GDP ratio is high and the country has pursued an extremely aggressive fiscal and monetary policy. So, the risk of a global business cycle contraction exists, but the Indian business cycle is in its initial stages. Post the fall of the market in 2018, its rally was concentrated and led by growth stocks. However, post October 2020, we have seen a broader rally and going forward it may continue as the economy opens up further. In the interim, markets are likely to be choppy and volatility poses a risk to investor returns.
Therefore, it is time for investors to revisit their portfolios and broad-base allocations, even within equity, to minimize risk. Flexicap mutual fund schemes offer this opportunity on a platter. The surge in investor funds into this category has taken the overall assets under management to around ₹1.6 trillion as of end-May.
Flexicap funds are dynamic with no prescribed formula by the market regulator on asset allocation across market capitalization categories. So, in a flexicap fund, it is the fund manager’s discretion to plan the portfolio allocation across industry sectors and categories such as large-, mid- and small-cap. The onus is on the fund manager to adapt faster to changing business cycles, take advantage of sector rotation in the markets, absorb market volatility and minimize downside risks.
Reasons to buy flexicap funds: Usually, flexicap funds are liked for their diversified approach, with a neat blend of stock-picking strategies. Large-cap stocks are driven by earnings growth and have the benefits of stability and liquidity. Usually, these investments are driven by changes in global and domestic macroeconomic indicators such as inflation and interest rates, business cycle changes, valuations and future earnings potential of companies. Hence, it is a top-down investment approach.
Small- and mid-caps, however, give the opportunity to invest in unexplored ideas. Therefore, they are stock-specific investments, often sector-agnostic and the result of a bottom-up approach in investing. They are deep-dive value bets and have the potential to turn into multi-baggers, when the Street recognizes their worth. In a growth phase, they can lead to capital appreciation.
Straddling these realms based on the state of the economy and markets is possible in flexicap funds. The idea is to build a balanced portfolio compared with large-, mid-, small- and or even multi-cap funds, which are straitjacketed.
The right time to invest in flexicap funds: It is very likely that markets could remain volatile in the near term owing to various uncertainties prevailing across global economies. The US Federal Reserve’s decision on tapering stimulus could impact investor flows in various asset classes, especially into emerging markets. Besides, the pace of vaccination and the fear of a third wave looming on the sidelines are added risks to economies returning to normalcy. While India is on the path to economic recovery, inflation and an increase in interest rates over the medium term could be dampeners. Against this backdrop, large-caps limit downsides and provide liquidity to the portfolio. Flexibility in allocation makes it possible to switch, if and when needed, to mid- and small-caps, which are better positioned to capture potential upside from the expected economic recovery.
Besides, the diversified portfolio ensures balance between risk and return. This is why flexicap funds are capable of delivering steady returns across market cycles.
Rajat Chandak is senior fund manager at ICICI Prudential AMC.
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