Investors Make a Strategic Shift Towards Flexi-Cap Funds
A significant change is underway in how Indian investors are approaching the stock market through mutual funds. After a prolonged period of chasing high returns in small- and mid-cap schemes, a sense of caution is setting in. The new favourite is the flexi-cap category, which offers fund managers the freedom to invest across large, mid, and small-sized companies without any fixed allocation limits.
This strategic move comes at a time when stock valuations are high across the board, but the momentum in corporate earnings is showing signs of cooling down. Investors are seeking a safer harbour within the equity space, and the dynamic nature of flexi-cap funds provides just that.
The Numbers Tell the Story
The data from the Association of Mutual Funds in India (Amfi) makes this shift crystal clear. In the month of October, net inflows into flexi-cap mutual funds soared by 27% month-on-month to reach ₹8,923 crore. This surge is particularly striking because it happened while the overall inflow into equity mutual funds fell by nearly 19% during the same period.
The momentum has been building all year. Compared to October of the previous year, inflows into the flexi-cap category are up a staggering 72%. This sustained interest has pushed the total assets managed by these 43 schemes to approximately ₹5.3 trillion as of October. This makes the flexi-cap segment larger than any of the dedicated large-cap, mid-cap, or small-cap categories, which each manage assets between ₹3.2 trillion and ₹4.1 trillion.
In fact, a detailed analysis reveals that flexi-cap funds were the sole category to see an increase in net inflows during October. Flows into dedicated large-cap, mid-cap, and small-cap funds all declined—a trend not witnessed in at least the last year and a half.
Why the Sudden Preference for Flexibility?
The primary driver behind this change is the challenging valuation landscape. A Mint analysis shows that a majority of stocks in the large-cap and small-cap indices are now trading above their long-term average price-to-earnings (P/E) ratios. This makes finding undervalued opportunities difficult and limits the potential for massive gains, especially with a modest earnings outlook.
Experts point out that while the mid-cap index might appear relatively cheaper, the upside is narrower than it seems. Sonam Srivastava, Founder and Fund Manager at Wright Research PMS, cautions that the average P/E for mid-caps was shaped by an unusually strong liquidity period and may not be easy to replicate.
Gaurav Garg, a Research Analyst at Lemonn Markets Desk, believes that large caps are poised to outperform small and mid-caps over the next 6 to 12 months, thanks to more reasonable valuations and strong interest from institutional investors.
Earnings Momentum is Losing Steam
The September-quarter earnings reports further justify the investor caution. The analysis of corporate results reveals that the profit growth was not driven by a broad-based recovery in demand.
- Large-caps saw a massive 43% jump in net profit, but this was heavily supported by a 65% surge in non-core income, not core operations.
- Mid-caps displayed a slowdown, with core income growth decelerating to around 9% over the past four quarters.
- Small-caps showed sharp profit growth of 38%, but this was largely due to a low base of comparison from the previous year.
This reliance on one-off income and base effects suggests that the stellar earnings growth for small and mid-cap companies (SMIDs) is normalizing. Data from Kotak Institutional Equities confirms this, showing that earnings downgrades outnumbered upgrades across market caps in the second quarter.
Satish Ramanathan, CIO-Equity at JM Financial Asset Management, noted that flexi-cap inflows have remained firm despite recent market volatility. He expects this trend to continue, driven by steady systematic investment plans (SIPs) and a growing demand for diversified all-cap exposure.
In a market where conviction is crowded out by high valuations, the ability of flexi-cap fund managers to nimbly pivot between market segments is becoming the most valuable asset for investors looking to stay invested in equities while managing risk.
