Why attention is shifting back to diversified equity funds

India’s equity market is entering a phase where returns are no longer uniform and leadership is becoming more dispersed. The result is that investors are rediscovering the charm of diversified equity funds, including flexi-cap, multi-cap, and large & mid-cap schemes, which blend growth potential with risk control. There is now a shift from chasing “top-performing” categories to seeking risk-adjusted, consistent returns.

According to Value Research data as of October 15, over the past year, about 46% of flexi-cap funds in the diversified equity category outperformed their benchmarks. In comparison, around 37% of multi-cap funds and 47% of large & mid-cap funds delivered returns higher than their benchmarks.

“Selective, bottom-up stock picking and concentrated bets in quality companies will matter more. In this environment, diversified funds can do well because they can pick winners across caps and sectors,” says Chandraprakash Padiyar, Senior Fund Manager, Tata MF.

For much of the post-pandemic period, investors poured money into high-beta categories, small- and mid-cap funds, thematic plays, and even new-age sectors funds such as manufacturing and public sector undertaking (PSU). But as those rallies stretched valuations, the focus began to shift toward stability.

“Earlier, , defence, and small caps were outperforming by a mile. But not anymore. Investors have noticed that the dispersion of returns is wide and unpredictable. That’s why flows are now moving to diversified categories like flexi-cap and multi-cap funds, which are best suited as 'core holdings' for investors” says Aashish Somaiyaa, CEO, WhiteOak Capital MF.

Diversified equity funds, unlike single-theme or single-cap strategies, invest across sectors and market capitalisation. Within this umbrella, flexi-cap, multi-cap, and large & mid-cap funds each play distinct roles.

A flexi-cap fund gives fund managers the flexibility to adjust allocations across large, mid, and small-cap stocks depending on market conditions. In contrast, a multi-cap fund is required to maintain at least 25% in each of these three segments, offering a more structured approach with less room for flexibility. Meanwhile, large and mid-cap funds must allocate a minimum of 35% to both large and mid-cap stocks, striking a balance between stability and growth.

A multi-cap fund works with set allocation features, whereas a flexi-cap allows the investment team to move freely between segments. Whenever valuations move materially higher in one part of the market, flexi-cap funds can rebalance. When valuations are fair across segments, multi-cap funds work well. Over a decade, both can deliver similar outcomes but with different paths.

For fund managers, this phase is about selectivity and discipline. Opportunity now lies across caps, but one must tread with caution. “Our flexi-cap strategy is designed to be truly dynamic,” says Padiyar. “Currently, we hold around 48% in large caps, 24% in mid caps, and 24% in small caps. Large caps appear fairly valued, while within mid and small caps, we’ve used the recent correction to add high-quality names.”

Sorbh Gupta, Head, Equity, Bajaj Finserv MF, argues that diversified equity strategies give fund managers the flexibility to navigate uncertainty. “They allow us to adjust allocation as leadership changes. There’s always a segment offering value while others are overheated. That dynamic approach is the real strength of diversified funds.”

At Kotak Mahindra Mutual Fund, Harsha Upadhyaya, President and CIO Equity, favours large caps. He believes that diversified funds help investors avoid the pitfalls of narrow themes. “If you invest in a single-sector fund, your outcome depends entirely on that one theme. In a diversified portfolio, the manager can rotate exposure as market leadership shifts, something sectoral funds can’t do.”

For product strategists in asset management companies, the resurgence of diversified funds is also about simplicity. Most investors struggle to decide how much to put in large, mid, or small caps. “A flexi-cap or multi-cap fund takes that decision away from them, offering a built-in balance. When valuations are stretched in one area, but earnings growth is visible elsewhere, diversified funds automatically capture that mix,” says Rajesh Jayaraman, Head Products, Nippon India Mutual Fund.

From an industry perspective, the shift toward diversified funds signals investor maturity. “As growth cycles normalise and liquidity-driven excesses fade, diversified funds, particularly multi cap and quality-oriented themes, are becoming the cornerstone of portfolios again,” says D.P. Singh. Deputy Managing Director & Joint Chief Executive Officer, SBI MF.

Chasing returns in the past has often hurt outcomes, but the rising adoption of systematic investment plans (SIPs) and the growing hybrid category show that investors now appreciate asset allocation and diversification. Somaiyaa credits recent regulatory steps for improving investor behaviour. “Mandating information ratio disclosure has been a great step. It encourages investors to focus on consistent, risk-adjusted performance, not just one-year alpha. That’s what builds long-term trust.”

Distributors and registered investment advisors (RIAs) are witnessing the same rebalancing. Vishal Dhawan, Mumbai-based RIA, says investors are becoming more cautious after the volatility in mid and small-caps. “There’s a slowdown in flows into thematic and small-cap funds,” he observes. “Investors are gradually moving toward flexi-cap and large-cap-oriented diversified funds. It’s a sign that risk awareness is increasing.”

Diversified funds have a behavioural advantage. SIPs in diversified categories, especially flexi cap and large & mid cap, have stronger persistence, says Amit Bivalkar, Founder of Sapient Finserv . He believes diversified funds suit almost all investor types from beginners to retirees. These funds are the core of most portfolios and survive downturns. In small-cap or thematic funds, SIP stoppages rise the moment performance dips.

Fund managers and advisors agree that India’s market leadership is becoming fragmented, thus providing a perfect backdrop for diversified strategies. Experts recommend investors blend diversified funds as their core, complemented by some sectoral exposure, for both stability and opportunity.

@Riddhima765