A Soliloquy on Portfolio Consciousness
Comparing Mutual Funds?
Here’s What Investors Miss When They Only Look at Returns
When comparing mutual fund schemes, the most common metric investors rely on is returns. It feels intuitive — if a fund has delivered higher returns in the past, it must be better. But here’s the reality: returns are the result, not the process.
What actually shapes those numbers are hidden drivers like portfolio allocation, market-cap exposure, diversification, churn, and the fund manager’s investment philosophy. Two funds in the same category can have similar short-term returns, but behave very differently in the long run or during market volatility.
If you want to make informed investment decisions, you need to dig deeper. Here’s why looking beyond returns matters when evaluating mutual funds across categories.
Flexi-Cap Funds: Same Freedom, Different Strategies
Flexi-cap funds enjoy the flexibility to invest across large, mid, and small caps. But that freedom means no two funds are alike.
- Allocation tilt: Some flexi-caps are large-cap heavy for stability, while others lean into mid- and small-caps for growth. The former offers smoother returns, the latter brings more volatility.
- Investment style: A growth-oriented fund will behave differently from one following value or GARP (Growth at a Reasonable Price). Over short periods, returns may look similar, but styles diverge over longer cycles.
- Portfolio structure: Some funds run concentrated portfolios (25–30 stocks) to seek higher alpha, while others diversify across 50–70 names. Parag Parikh Flexi-cap goes a step further by adding global stocks and holding cash when valuations look stretched.
- Churn ratio: A high turnover may boost short-term agility but increases costs and risks. A lower churn reflects patience and conviction.
- Investor takeaway: In flexi-cap funds, check allocation bias, style, and portfolio depth before assuming one is “better” just because of past returns.
Large & Midcap Funds: Mandate Meets Manager Choice
By rule, large & midcap funds must hold at least 35% each in large- and mid-cap stocks. The remaining 30% is flexible — and that’s where managers put their stamp.
- Flexible 30%: Some managers use it to strengthen stability with more large-caps, while others take higher mid-/small-cap exposure for alpha.
- Portfolio spread: Fund sizes vary widely — from concentrated portfolios of 30 stocks to broad-based portfolios of 100+. For example, HDFC’s large & midcap fund owns over 200 stocks, while others stick to 30–40 names.
- Manager philosophy: A value-driven manager may look sluggish in bull runs but resilient in downturns, while a momentum-driven approach can ride rallies but struggle in corrections.
- Investor takeaway: Don’t just compare 1- or 3-year returns. Study how managers use the discretionary portion and what philosophy guides them.
Midcap & Small-Cap Funds: Liquidity Is the Hidden Risk
Midcap and small-cap funds must allocate at least 65% to their respective segments. The remaining 35% can be placed flexibly — and this often makes or breaks performance.
- Use of flexibility: Managers may deploy the balance in large-caps for stability, in cash for risk control, or in small/mid-caps for higher upside.
- Liquidity concerns: Small-caps can face severe stress during market downturns, as exits become difficult. Funds that manage liquidity well, either with cash buffers or staggered exits, tend to protect investors better.
- Portfolio depth: Some funds limit themselves to 40–60 names, while others spread widely. Nippon Small Cap, for instance, holds over 230 stocks, spreading exposure thinly to reduce liquidity risk.
- Investor takeaway: In these categories, returns often hide fragility. Pay attention to diversification, liquidity handling, and portfolio design.
Multi-Cap Funds: Balance or Bias?
By regulation, multi-cap funds must invest 25% each in large, mid, and small caps. The discretionary 25% is what differentiates them.
- Manager bias: If tilted toward mid/small caps, the fund may act more aggressively than expected. If tilted toward large-caps, it may be more stable but lower on alpha.
- Volatility vs stability: Despite being branded “multi-cap,” the risk profile may vary sharply.
- Churn levels: High churn suggests frequent tactical moves, which may work in short bursts but add to costs and inconsistency.
- Investor takeaway: Multi-cap doesn’t always equal balanced. The extra 25% discretion often defines the real behaviour.
Balanced Advantage Funds (BAFs): One Name, Many Faces
Balanced Advantage Funds are often misunderstood. Despite the “balanced” tag, their equity exposure, allocation methods, and strategies vary significantly.
- Equity exposure: Some keep core equity below 40% (like SBI, ICICI), while others go up to 70–75% (like Edelweiss, Bajaj).
- Dynamic allocation: Counter-cyclical funds increase equity when markets fall, while pro-cyclical funds increase equity during rallies. This results in significantly different investor experiences.
- Rebalancing frequency: Some adjust daily, others quarterly. This changes how quickly they respond to markets.
- Equity styles: Even within their equity portion, some stick to large-caps while others mix in mid- and small-caps.
- Investor takeaway: Two BAFs with similar returns today may perform completely differently tomorrow. Match the fund’s method to your risk appetite, not just its 1-year performance.
Multi-Asset Funds: More than Just a Mix
Multi-asset funds appear well-diversified by design — they can invest across equity, debt, gold, silver, commodities, REITs/InvITs, and global equities. But the way they allocate makes all the difference.
- Commodities: Some funds use gold or silver tactically; others hardly touch them, even during rallies.
- Real assets: REITs/InvITs add income and diversification, yet many funds skip them.
- Global equities: Funds like DSP and Nippon allocate ~20% overseas, gaining from U.S. markets. Others remain purely domestic.
- Equity exposure: Some stay below 35% equity, others exceed 65%. This also changes tax treatment — equity-heavy funds get favourable taxation compared to hybrid-heavy ones.
- Investor takeaway: Don’t assume “multi-asset” automatically means safer or better. Look at the exact mix and tax rules before investing.
Other Vital Factors beyond Returns
No matter which category you’re considering, two broader factors are crucial:
- Fund manager tenure & philosophy: Experienced managers, supported by strong fund-house philosophies, often ensure consistency across market cycles.
- Expense ratio (TER): A low-cost fund is not always superior. Sometimes, slightly higher expenses are justified if the fund delivers consistency and better risk-adjusted returns.
The Bottom Line: Do the Homework
Returns are important, but they’re only the visible tip of the iceberg. The real insight lies in understanding what drives those returns — the allocation strategy, diversification, the fund manager’s approach, and risk profile.
Two funds in the same category may deliver similar returns today, but when markets rally or crash, their differences become apparent. As an investor, your focus should be on finding a fund that aligns with your risk appetite and financial goals, not just the one that tops past-return charts.
Because in mutual funds, what lies beneath the returns matters more than the returns themselves.
Disclaimer: The information provided in this article is for educational and informational purposes only and should not be construed as investment advice or a recommendation to buy, sell, or hold any mutual fund or financial product. Mutual fund investments are subject to market risks, including possible loss of principal. Past performance is not indicative of future results. Investors are advised to carefully read all scheme-related documents and consult with a qualified financial advisor before making any investment decisions.
