SEBI’s 25% Allocation Rule for Multi-Cap Funds: A Complete 2025 Breakdown

 If you have ever wondered why your multi-cap mutual fund seems unusually “balanced” across large-cap, mid-cap, and small-cap stocks — even when the market is visibly favouring one segment — you’re not alone. This trend traces back to SEBI’s famous 2020 multi-cap regulation, a rule that fundamentally reshaped India’s equity fund landscape.

But now that five years have passed, investors, fund managers, and financial analysts are asking a new question:

“Is SEBI’s 25% rule still the right framework for 2025 and beyond?”

This in-depth article walks you through everything — from how the rule evolved to why the debate around it has become so heated — in a friendly, human way that even new investors can understand. As someone who has worked in taxation, compliance, and financial analysis for over a decade, and as the founder of Manika TaxWise, I’ll also share practical examples and my professional perspective.

 

TABLE OF CONTENTS

1. Introduction
2. Background: Why SEBI Introduced the Rule
3. What Exactly Does the 25-25-25 Rule Mean?
4. Why the Rule Matters Even More in 2025
5. The Growing Debate: Pros vs Cons
6. Impact on Investors
7. Impact on Fund Managers
8. Multi-Cap vs Flexi-Cap: Which One Makes More Sense Today?
9. Real-World Examples (Humanized Scenarios)
10. Future Outlook: Will SEBI Modify the Rule?
11. Expert Insights from Manika TaxWise
12. FAQs
13. Author Bio

 

Introduction: How a Single Regulation Changed an Entire Category

Back in September 2020, when the economy was recovering from the pandemic and volatility was at an all-time high, SEBI made a bold decision:

Every multi-cap mutual fund must allocate a minimum:

• 25% to large-caps
• 25% to mid-caps
• 25% to small-caps

This rule didn’t just change portfolios.
It changed how fund managers think, how investors choose funds, and how the mutual fund universe is structured.

Fast-forward to November 2025, and the conversation has taken a sharp turn. Is the rule truly helping investors, or has it become a “straightjacket” limiting fund managers?

Let’s unpack the full story.

 

Background: Why SEBI Introduced the 25% Rule

Before 2020, multi-cap funds were a bit like free birds — flexible, dynamic, and allowed to invest wherever they saw opportunity. In fact, many funds branded as “multi-cap” were heavily tilted toward large-cap stocks, some even with 80–85% in large-caps.

So technically, they looked more like large-cap funds wearing a multi-cap mask.

SEBI noticed three major problems:

1. Misleading Fund Names

Investors saw “multi-cap” and assumed broad diversification, but many funds barely touched mid-caps or small-caps.

2. Benchmarking Issues

Funds claimed multi-cap status but used large-cap benchmarks — this created an imbalance in performance comparison.

3. Lack of Transparency

The average investor couldn’t see what they were actually buying.

To solve these problems, SEBI issued the 11 September 2020 circular, which:

• Raised minimum equity exposure from 65% to 75%
• Mandated a 25-25-25 allocation to large, mid, and small-caps

It was a bold step to ensure:

• Genuine diversification
• Honest fund labeling
• Better category definition

And to be fair — it worked initially.

 

What Exactly Does the 25% Rule Enforce?

To put it simply, if a fund calls itself multi-cap, it must follow this structure:

Mandatory Allocations

• 25% in large-caps
• 25% in mid-caps
• 25% in small-caps

Equity Threshold

• Minimum 75% equity exposure

Remaining 25%

This portion can be adjusted freely:

• More large-cap
• More mid-cap
• More small-cap
• Or in debt/liquid (depending on scheme mandate)

This is where the rule creates tension — only 25% of the portfolio is flexible.

In contrast:

Flexi-Cap Funds

• Only need 65% in equities
• No cap-based restrictions

This makes flexi-caps much more adaptable.

 

Why This Rule Matters Even More in 2025

The Indian equity market has gone through several unpredictable cycles between 2020 and 2025:

• A small-cap boom (2021)
• A mid-cap rally (2023)
• Large-cap outperformance (2024)
• Another small-cap correction (2025)

In each of these cycles, flexibility was key. But multi-cap funds were forced to maintain 25% exposure across all segments — even when valuations were stretched or risks were elevated.

A Business Today (May 2025) analysis highlighted that many investors are switching from multi-cap to flexi-cap funds because of this rigidity.

Their words were sharp but accurate:

“While the rule ensures diversification, it restricts the fund manager’s ability to minimize risks and maximize opportunities.”

This is precisely why the debate has intensified.

 

The Growing Debate: Pros vs Cons of SEBI’s Rule

Let’s break down the arguments like a real conversation you'd overhear at a coffee shop between two finance professionals.

 

A. Arguments Against the 25% Rule

1. Strategic Inflexibility

Imagine small-caps are crashing — like they did briefly in early 2025.
Even if a fund manager wants to cut exposure to 5–10%, they can’t.
They must keep 25%.

This forces managers into risk when they don’t want it.

2. Sub-optimal Capital Deployment

What if large-caps are cheap and everything else is expensive?
Too bad — the fund still has to park 50% in mid and small-caps.

3. Higher Turnover Costs

To maintain strict ratios, the fund must constantly rebalance:

• Buy small-caps after a fall
• Sell large-caps after a rise

This leads to:

• More brokerage costs
• Higher capital gains distributions (for some fund types)
• Reduced long-term compounding

4. Liquidity Stress in Small-Caps

For funds with ₹20,000 crore+ AUM, finding quality small-caps becomes difficult.

High buying pressure artificially boosts small-cap valuations.

Even Morningstar highlighted this in their 2024–25 fund commentary.

5. Reduced Differentiation Among Funds

Every multi-cap fund starts looking the same because they follow the same structure.

This forces investors to choose flexi-caps instead.

 

B. Arguments In Favour of the Rule

1. Guaranteed Diversification

Not all investors understand volatility.
The rule ensures basic diversification — even for beginners.

2. Transparency

What you see is what you actually get.

3. Prevents “Fake” Multi-caps

Without regulation, funds could:

• Label themselves multi-cap
• Invest 90% in large-caps
• And confuse investors

4. Protects Retail Investors

Smaller investors often don’t know how to identify manipulation or misallocation.

SEBI gives them a guardrail.

5. Enhances Long-Term Stability

Diversification smoothens returns — especially over 7–10 years.

 

How the Rule Impacts Investors (2025 Perspective)

You might wonder — “So what does this mean for me?”

Here’s the simple summary:

Pros for Investors

• Stable diversification
• Lower long-term volatility
• Transparency in portfolio structure
• Helping beginners avoid one-sided risk

Cons for Investors

• Underperformance during certain cycles
• When small-caps fall, your fund still has 25%
• Fewer fund options with real innovation
• Better suited alternatives (Flexi-caps) may exist

Ultimately, multi-cap funds became safer but less competitive.

 

How the Rule Impacts Fund Managers

Instead of stock picking based solely on merit, fund managers now:

• Fight allocation constraints
• Increase rebalancing
• Are sometimes forced to buy overvalued small-caps
• Lose tactical advantage

Many top managers have openly expressed frustration — not because they oppose regulation, but because rigidity kills performance.

 

Multi-Cap vs Flexi-Cap: Which Fund Wins in 2025?

If you open any major investment forum right now, this is the most common debate.

Here’s a clean breakdown:

Feature	Multi-Cap (25% Rule)	Flexi-Cap
Allocation	Mandatory 25% each	Fully flexible
Risk	Balanced but forced small-cap exposure	Depends on manager
Return potential	Moderate	Higher (if manager is skilled)
Ideal for	Beginners	Experienced investors
Regulatory pressure	High	Low

Final Verdict

• Flexi-cap funds are the current favourite for 2025
• Multi-cap funds suit conservative, long-term investors

 

Real-World Scenarios to Understand the Rule

Let’s simplify things with two relatable cases.

 

Scenario 1: “Aisha’s Dilemma During a Market Crash”

Aisha is a salaried professional in Mumbai. She invested ₹3 lakh in a multi-cap fund in late 2024.

In early 2025, small-caps unexpectedly corrected by 22%.

Because SEBI mandates 25% in small-caps:

• Her fund couldn’t reduce exposure
• Her portfolio fell more than expected
• A Flexi-cap fund in comparison reduced small-caps and protected capital

She felt frustrated — not because the fund made bad decisions, but because the fund was not allowed to decide at all.

 

Scenario 2: “Rahul’s 7-Year SIP Growth”

Rahul started his SIP in 2018 and continued through the 2020 regulatory change.

He benefited from:

• Consistent diversification
• Multi-cap stability during volatile mid-cap squeezes

Even today, Rahul’s diversified exposure looks healthier than concentrated large-cap SIPs.

This proves:
The rule helps investors who prefer stable long-term compounding.

 

Will SEBI Modify the Rule Soon?

Here’s the big million-rupee question: Will SEBI change the rule?

Based on industry trends, expert opinions, and recent AMC feedback, here’s the likely outcome:

Most Likely Scenario (2025–2026)

SEBI may:

• Create a new category: “True Multi-Cap (Flexible)”
• Or convert existing Flexi-caps into multi-caps with more clarity
• Or reduce mandatory small-cap allocation from 25% to 15%

Least Likely Scenario

Removing the rule entirely.

Why?

SEBI’s primary goal is investor protection, not fund manager convenience.

 

Expert Insights from Manika TaxWise

At Manika TaxWise, we regularly advise individuals and small businesses on:

• Investment tax planning
• Mutual fund taxation
• Capital gains optimization
• Long-term financial structuring

Here’s our insight:

If you're a beginner investor, multi-cap funds offer a structured, diversification-first entry point.

If you prioritize performance, consider flexi-caps or large & mid-cap funds.

If you worry about small-cap volatility, stay cautious with multi-caps in 2025.

We always recommend aligning investments with:

• Your income stability
• Risk appetite
• Investment horizon
• Tax planning strategy
• Overall financial goals

For personalized guidance, Manika TaxWise will soon be launching a free mutual fund guide for new investors.

 

Frequently Asked Questions (FAQ)

1. Does SEBI’s 25% rule increase risk?

It increases small-cap exposure — which is risky — but ensures diversification too.

2. Can a multi-cap fund invest more than 25% in one segment?

Yes, in the remaining flexible 25%.

3. Which fund is better in 2025: Multi-cap or Flexi-cap?

Flexi-cap funds generally offer better tactical performance.

4. Why did SEBI enforce such a rule?

To prevent misleading fund categorization.

5. Should new investors avoid multi-cap funds?

Not necessarily — they are great for disciplined long-term diversification.

 

Author Bio

Written by: Manika TaxWise
Expert Accountant, Financial Analyst, and Founder of Manika TaxWise

With over 11 years of experience in taxation, accounting, investment advisory, and financial content writing, I help individuals and business owners navigate India’s complex financial landscape with clarity and confidence. My work blends real-life knowledge, industry insights, and practical techniques to make finance simple and accessible for everyone.