The 25-25-25 Rule: How SEBI Forces Multi Cap Funds to Spread Across Large, Mid and Small Caps

When the Securities and Exchange Board of India released circular SEBI/HO/IMD/DF3/CIR/P/2020/172 on 11 September 2020, it rewrote the rulebook for one of the most popular diversified equity categories in the country. From that date, every Multi Cap fund must hold a minimum of 25% each in large cap, mid cap and small cap stocks, pushing the floor for total equity exposure to 75%. Before this circular, a fund labelled "Multi Cap" could park 80% or more of its money in large caps and still keep the name, leaving investors exposed to a label that promised diversification it did not deliver.

The fallout was immediate. Within eight weeks SEBI issued a second circular dated 6 November 2020 creating the Flexi Cap category, a home for managers who wanted to keep allocating across market caps without a fixed 25-25-25 straitjacket. The result is that Indian investors today choose between two superficially similar products that behave very differently in a drawdown. This pulse compares Multi Cap funds against Flexi Cap funds for the goal of long-term equity wealth building, using only the allocation rules SEBI has published and the capital gains rates notified in Budget 2024.

Side-by-Side Comparison

The single dividing line between the two categories is the minimum allocation mandate. A Multi Cap fund is bound by the 25-25-25 floor introduced on 11 September 2020, so at least 75% of its corpus is permanently spread across the three market cap buckets. A Flexi Cap fund, created by the 6 November 2020 circular, carries only the standard equity-fund floor of 65% in equities and is otherwise free to tilt 100% of that equity sleeve into large cap names if the manager turns defensive.

To make the buckets concrete, SEBI defines large cap as the 1st to 100th company by full market capitalisation, mid cap as the 101st to 250th, and small cap as the 251st company onward. AMFI publishes this ranked list twice a year, and it is the same classification both categories must follow when reporting their holdings. A Multi Cap fund running Rs 10,000 crore must therefore keep at least Rs 2,500 crore in companies ranked 251 and below, a constraint a Flexi Cap manager can avoid entirely.

That forced small cap exposure is the crux of the risk difference. Small caps, the 251st-and-below cohort, historically swing far harder than the top 100 in both directions, so the 25% mandate raises the volatility of a Multi Cap fund relative to a Flexi Cap fund that has rotated into large caps. Investors comparing the two should map their own holding horizon against this structural difference before deciding, and can model contributions through Oquilia's SIP calculator or test a one-time deployment with the lumpsum calculator.

It is worth remembering why SEBI created a second category at all. The 11 September 2020 circular fixed a hard 25% floor on each of the three market cap buckets, and within eight weeks the 6 November 2020 circular introduced Flexi Cap as an alternative for managers who did not want those small cap and mid cap floors imposed on them. The Flexi Cap structure was, in effect, the regulator's pressure valve: it preserved a diversified-equity option carrying only the 65% equity floor, while keeping the Multi Cap label honest by reserving it for funds that genuinely spread across all three cap segments. Understanding that the two products were born from the same September-to-November 2020 episode helps explain why they sit side by side on most fund platforms today.

Tax Treatment

Here the two categories converge completely. Because both a Multi Cap fund (minimum 75% equity) and a Flexi Cap fund (minimum 65% equity) clear the 65% domestic-equity threshold, both are classified as equity-oriented funds under the Income-tax Act, and the capital gains rules notified in Budget 2024 apply identically to each. There is no tax arbitrage between the two structures, so the choice rests entirely on allocation and risk, not on post-tax efficiency.

For units held for 12 months or less, gains are short-term and taxed under Section 111A of the Income-tax Act. Budget 2024 raised the STCG rate on equity-oriented funds to 20%, effective for transfers on or after 23 July 2024. For units held beyond 12 months, gains are long-term under Section 112A: the LTCG rate is 12.5%, and the first Rs 1,25,000 of long-term equity gains in a financial year is exempt. The exemption ceiling was lifted from Rs 1,00,000 to Rs 1,25,000 in the same Budget.

A worked illustration shows how little tax separates them. If you book Rs 3,25,000 of long-term gains in FY 2025-26 from either category, the first Rs 1,25,000 is exempt and the remaining Rs 2,00,000 is taxed at 12.5%, a liability of Rs 25,000 before the 4% health and education cess. Neither the Multi Cap nor the Flexi Cap label changes that figure by a single rupee, which is why disciplined investors compare these two on their equity-curve behaviour rather than their tax slips. Note that no Section 80C deduction attaches to either category unless the fund is also an ELSS scheme; for a tax-linked equity product, the ELSS calculator is the better planning tool.

Who Should Pick Which

The decision turns on how much small and mid cap exposure an investor genuinely wants locked in. A Multi Cap fund suits someone who wants the 25% small cap and 25% mid cap allocation guaranteed by the 11 September 2020 mandate, accepts that the small cap leg will deepen drawdowns, and has a holding horizon of at least seven to ten years to ride out that volatility. The forced diversification is a feature for an investor who fears that a discretionary manager will crowd into large caps and dilute the growth premium that mid and small caps can offer over a full cycle.

A Flexi Cap fund suits an investor who trusts an active manager to move between the 1st-100th, 101st-250th and 251st-onward buckets as valuations shift, and who wants the option of a defensive large cap tilt during stretched markets. Because the only hard floor is 65% in equities, a skilled Flexi Cap manager can cut small cap weight to near zero ahead of a correction, something a Multi Cap manager bound by the 25% floor legally cannot do. The trade-off is that the investor is buying manager skill rather than a rule, so the quality and tenure of the fund manager matter far more in this category.

For first-time equity investors with a horizon under five years, neither category is ideal, because both carry a 65%-plus equity floor and the associated mark-to-market risk. Such investors are usually better served mapping a goal first and sizing the equity allocation accordingly, which they can do with Oquilia's mutual fund returns calculator before committing capital. Whichever category you choose, judge it against its stated benchmark index and watch the expense ratio, since a higher fee compounds against you regardless of the allocation rule.

FAQ

What exactly is the 25-25-25 rule for Multi Cap funds?

It is the minimum allocation mandate from SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/172 dated 11 September 2020. A Multi Cap fund must invest at least 25% each in large cap, mid cap and small cap stocks, which fixes its minimum total equity exposure at 75%. The remaining 25% is at the manager's discretion across any market cap or permitted asset class.

How is a Flexi Cap fund different from a Multi Cap fund?

A Flexi Cap fund, created by SEBI's 6 November 2020 circular, has no minimum allocation to any single market cap segment. It only has to hold at least 65% in equities, so a Flexi Cap manager can run 90% large cap if they wish, whereas a Multi Cap fund is locked into the 25-25-25 floor from the 11 September 2020 circular.

Are Multi Cap and Flexi Cap funds taxed differently?

No. Both clear the 65% domestic-equity threshold and are treated as equity-oriented funds. Under Budget 2024, effective 23 July 2024, short-term gains on units held 12 months or less are taxed at 20% under Section 111A, and long-term gains beyond 12 months at 12.5% under Section 112A, with the first Rs 1,25,000 of long-term gains exempt each financial year.

Does the 25% small cap floor make Multi Cap funds riskier?

Structurally, yes. SEBI defines small caps as companies ranked 251st and below by market capitalisation, the most volatile cohort. Because a Multi Cap fund must hold at least 25% there at all times, it cannot reduce that exposure ahead of a correction, while a Flexi Cap fund operating only under the 65% equity floor can. This typically gives Multi Cap funds deeper drawdowns in falling markets.

What is the LTCG exemption limit for these funds in FY 2025-26?

The annual long-term capital gains exemption for equity-oriented funds is Rs 1,25,000, raised from Rs 1,00,000 by Budget 2024. Gains above that ceiling are taxed at 12.5% under Section 112A, plus a 4% health and education cess on the tax. The exemption resets each financial year and applies across all your equity LTCG combined.

How are large, mid and small caps defined for these funds?

SEBI uses AMFI's ranked list of companies by full market capitalisation, published twice a year. Large cap means the 1st to 100th company, mid cap means the 101st to 250th, and small cap means the 251st company onward. Both Multi Cap and Flexi Cap funds must report their holdings against this same classification.

Can I claim a Section 80C deduction by investing in a Multi Cap or Flexi Cap fund?

No, not on the basis of the category alone. Section 80C tax benefits attach only to ELSS schemes, which carry a separate three-year lock-in. A plain Multi Cap or Flexi Cap fund gives you diversified equity exposure but no 80C deduction, so investors seeking the deduction should look specifically at an ELSS product instead.