Multi Cap vs Flexi Cap Funds: What SEBI's 25/25/25 Rule Really Forces Your Money Into

When SEBI issued circular SEBI/HO/IMD/DF3/CIR/P/2020/172 on 11 September 2020, it did something unusual for an Indian mutual fund category: it dictated not just how much equity a scheme must hold, but exactly how that equity should be spread across company sizes. The circular ordered every multi cap fund to keep a minimum of 75% of total assets in equity, with at least 25% each in large cap, mid cap and small cap stocks. That is the 25/25/25 rule, and it reshaped roughly Rs 1.5 lakh crore of assets almost overnight.

The rule exists because the label "multi cap" had drifted from its meaning. Before 11 September 2020, the older categorisation circular SEBI/HO/IMD/DF3/CIR/P/2017/114 dated 6 October 2017 defined a multi cap fund only as one investing a minimum of 65% in equity across market capitalisations, with no floor for any single segment. In practice, many funds parked the bulk of that 65% in large caps and held token mid- and small-cap positions, giving investors a large-cap-heavy portfolio under a diversified name. The 2020 circular closed that gap.

For anyone weighing a multi cap fund against its closest cousin, the flexi cap fund, the comparison below sets out where the two diverge, how each is taxed under the equity rules effective 23 July 2024, and which investor profile each one actually fits.

Side-by-Side Comparison

The essential difference is regulatory freedom. A multi cap fund runs on fixed floors set by the 11 September 2020 circular; a flexi cap fund, a category SEBI created two months later through circular SEBI/HO/IMD/DF3/CIR/P/2020/228 dated 6 November 2020, has only a single 65% equity floor and full discretion over market-cap mix.

The practical consequence shows up in a worked allocation. Take a notional Rs 10,00,000 invested at the regulatory minimums. A multi cap fund must hold the shape shown below, while a flexi cap fund manager could, in principle, put the entire equity sleeve into large caps.

Because a multi cap fund is contractually anchored to at least 25% in small caps and 25% in mid caps, it carries structurally higher volatility than a flexi cap fund that can retreat to large caps when conditions sour. To model how either mix compounds over 10 to 20 years, run the numbers through the SIP calculator or the lumpsum calculator before committing a rupee.

How SEBI Defines Each Cap, and Why the 25% Floors Bite

The 25/25/25 rule only works because SEBI first fixed what "large", "mid" and "small" mean. The 6 October 2017 categorisation circular (SEBI/HO/IMD/DF3/CIR/P/2017/114) ranks all listed companies by full market capitalisation: the 1st to 100th companies are large cap, the 101st to 250th are mid cap, and the 251st company onwards is small cap. AMFI publishes and updates this list every six months, and funds must realign to any reclassification within a defined window.

That definition is what gives the small-cap floor its bite. Requiring at least 25% in the 251st-and-below cohort forces a multi cap fund into the least liquid, most volatile slice of the market at all times, in bull runs and corrections alike. When the 11 September 2020 circular landed, industry bodies flagged exactly this liquidity concern, because collectively pushing a quarter of multi cap assets into small caps risked moving thinly traded prices.

SEBI's response was a phased compliance path. The circular gave each existing scheme one month from the date AMFI published its next stock list to rebalance; AMFI published that list in early January 2021, so most funds completed the shift by end-February 2021. Crucially, SEBI also permitted funds to sidestep the mandate entirely by converting to the newly minted flexi cap category, and several large schemes did precisely that in late 2020 and early 2021.

Tax Treatment

Here the two categories converge completely. Both a multi cap fund and a flexi cap fund hold well over 65% of assets in domestic equity, so both qualify as equity-oriented funds and are taxed identically under the capital-gains regime that took effect on 23 July 2024.

A worked example makes the LTCG maths concrete. Suppose you redeem units of a multi cap fund after three years and book a long-term gain of Rs 3,25,000 in a financial year. The first Rs 1,25,000 is exempt under Section 112A, leaving Rs 2,00,000 taxable at 12.5%, which is Rs 25,000, plus 4% cess of Rs 1,000, for a total of Rs 26,000. The same gain in a flexi cap fund is taxed to the identical rupee, because the tax code looks at the equity proportion, not the category name.

Short-term gains are dearer. If you exit either fund inside 12 months, the entire gain is taxed at 20% under Section 111A with no exemption, so a Rs 1,00,000 STCG attracts Rs 20,000 plus Rs 800 cess. One more point often missed: long-term gains charged under Section 112A do not qualify for the Section 87A rebate, even though that rebate was raised to Rs 60,000 for taxable income up to Rs 12,00,000 in the new regime for FY 2025-26. The 12.5% still applies on gains above the Rs 1,25,000 shield.

Investors chasing a tax deduction on the way in, rather than only a favourable rate on the way out, should note that neither category qualifies for Section 80C. That relief is reserved for ELSS funds, which carry a three-year lock-in and a separate mandate.

Who Should Pick Which

The choice turns on how much you trust a fund manager to time the market versus how much you want the rulebook to enforce diversification for you.

Pick a multi cap fund if you want enforced diversification. The 25/25/25 floors from the 11 September 2020 circular guarantee you never wake up to find your "diversified" fund is 90% large cap. For an investor with a 10-year-plus horizon who wants disciplined, always-on exposure to mid and small caps without watching allocations, the rule does the rebalancing work automatically. The trade-off is that the mandatory 25% small-cap floor means sharper drawdowns in corrections such as the small-cap sell-offs seen in early 2018 and mid-2022.

Pick a flexi cap fund if you back active judgement. With only a 65% equity floor and no cap-wise minimums from the 6 November 2020 circular, a flexi cap manager can raise cash-equivalent large caps to 80% ahead of a feared correction, then rotate into small caps when valuations turn attractive. This suits investors who accept that the manager's calls, right or wrong, will drive returns, and who prefer a smoother ride than a permanent 25% small-cap commitment allows.

Hold both, or neither, in specific cases. An investor already running dedicated large-, mid- and small-cap SIPs may find a multi cap fund duplicates exposure they can control more precisely themselves. Conversely, a first-time equity investor building a single core holding often gets cleaner, rule-bound diversification from a multi cap fund than from betting on one manager's flexi cap discretion. Whichever you choose, watch the expense ratio: a difference of even 0.75 percentage points a year compounds heavily over two decades.

Before deciding, map the choice to your goal amount and horizon. Model a target corpus in the lumpsum calculator and stress-test the monthly commitment in the SIP calculator, because the category matters far less than the amount and the years you stay invested.

FAQ

What exactly is the 25/25/25 rule for multi cap funds?

Under SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/172 dated 11 September 2020, a multi cap fund must invest a minimum of 75% of total assets in equity, split with at least 25% each in large cap, mid cap and small cap stocks. The remaining 25% is left to the fund manager's discretion.

How is a multi cap fund different from a flexi cap fund?

A multi cap fund is bound by the 25/25/25 floors from the 11 September 2020 circular. A flexi cap fund, created by SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/228 dated 6 November 2020, needs only 65% in equity with no market-cap-wise minimums, so its manager can hold up to 100% large cap or tilt heavily to small caps at will.

Are multi cap and flexi cap funds taxed the same way?

Yes. Both hold more than 65% in Indian equity, so both are equity-oriented funds. Long-term gains on units held over 12 months are taxed at 12.5% above a Rs 1,25,000 annual exemption under Section 112A, and short-term gains at 20% under Section 111A, effective 23 July 2024.

Does the 25% small cap floor make multi cap funds riskier?

Structurally, yes. The 11 September 2020 rule guarantees at least 25% in small caps (companies ranked 251st and below by full market capitalisation per the 6 October 2017 categorisation circular), a segment that swings more than large caps, whereas a flexi cap fund can cut small-cap exposure to zero in a downturn.

When did existing multi cap funds have to comply with the rule?

SEBI's 11 September 2020 circular gave schemes one month from the date AMFI published its next list of stocks, which appeared in early January 2021, so most funds complied by end-February 2021. Several large schemes converted to the flexi cap category instead of rebalancing.

Can I claim the Section 87A rebate on gains from these funds?

No. Long-term capital gains taxed under Section 112A are specifically excluded from the Section 87A rebate, even though that rebate rose to Rs 60,000 for taxable income up to Rs 12,00,000 in the new regime for FY 2025-26. The 12.5% LTCG rate applies on gains above the Rs 1,25,000 exemption regardless.