While small-cap funds are known for their high return potential, flexi-cap funds are valued for their dynamic asset allocation. A common question arises: Can flexi cap funds offer similar returns to small cap funds? Let's answer this.

Reasons Why Flexi Cap Is Better Than Small Cap

Here is why a flexi cap is better than a small cap:

Dynamic Asset Allocation

Flexi cap funds give fund managers the authority to invest across market capitalisations, including large, mid, and small-cap stocks, based on market trends and economic cycles. If small caps are expected to perform well due to favourable economic triggers, managers can increase allocation towards them. 

When valuations in small caps turn risky or overvalued, the fund can switch towards safer mid or large caps. This flexibility helps capture growth potential during bullish small-cap rallies, just like HDFC small cap fund do, but with the added benefit of reducing downside risks during market corrections.

Emerging Mid-to-Small Cap Leaders

Many future large-cap companies begin as small or mid-cap companies. In Flexi Cap funds, you get exposure to these early-stage growth companies without the limitation of sticking to small caps only. 

Your fund manager can add promising companies as they show improving fundamentals, and then hold them as they graduate into mid and large caps. This journey of compounding within a single fund, without needing to sell and reinvest elsewhere, can boost overall returns. 

Sector Rotation Opportunities

Flexi Cap funds are not bound by market cap or sectoral limitations. This means your fund manager can shift capital not only between company sizes but also between sectors. For instance, if the IT sector underperforms but manufacturing small caps are booming, the fund can focus on high-growth small-cap stocks within that sector. 

If defensive sectors like FMCG become attractive later, the fund can shift to large caps in that space. This dual rotation, across sectors and market caps, maximises your exposure to outperforming areas and avoids stagnating ones.

Mitigation of Liquidity Risks

Liquidity risk is a serious concern in the small-cap space. During market downturns, it becomes harder to exit small-cap positions without taking significant losses. Flexi Cap funds like HDFC Flexi Cap Fund avoid this issue by allocating smaller, tactical percentages to small caps. 

Even if the market becomes illiquid, they can absorb the shock because of their diversified structure. Small Cap funds, on the other hand, are more exposed and can suffer sharp NAV drops when redemptions rise.

Lower Portfolio Turnover

Flexi Cap funds tend to have a lower portfolio turnover compared to Small Cap funds. Since they are not forced to churn the portfolio to stay within a restricted market cap category, they can hold on to quality stocks longer. This reduces the transaction costs, capital gains tax, and slippage from frequent trading. 

These hidden costs can quietly eat into the returns of Small Cap funds, especially during volatile years. Over time, the cumulative impact of lower trading costs and long-term compounding on quality stocks can help Flexi Caps deliver competitive, if not better, post-cost returns.

Lower Overvaluation Risk

Small-cap stocks can quickly become overvalued during a bull market as investor enthusiasm drives up prices beyond fundamentals. In such situations, your Flexi Cap fund can book profits from these overheated small-cap positions and reinvest in undervalued mid-cap or large-cap stocks. 

Conclusion

While Small Cap funds aim purely for high growth, Flexi Cap funds offer a smarter, more balanced path. With their ability to shift between market caps and sectors, manage risks, and lower costs, they stand a strong chance of delivering returns close to, and sometimes even better than, Small Cap funds. So, if you want growth with a little cushion, Flexi Cap funds are definitely worth considering.