Can microcaps be a winner here?

Jaipur’s Rachna prefers to invest in smallcap and midcap companies. The reason is simple. When the market moves, there is more boom here. She also understands market risks and invests in smallcap mutual funds to limit it. Rachna is very excited about a recent news. Last month Motilal Oswal Asset Management Company (MOAMC) launched
Motilal Oswal Nifty Microcap 250 Index Fund.

Till now, Rachna was very happy with just smallcap funds. And now even microcap funds have come. She thinks that these funds can become the cheetah of the market. But is this belief of Rachna correct?
Should Rachna or any investor like you invest in Microcap Funds?

So, let us first know the features of Motilal Oswal Nifty Microcap 250 Index Fund.
This is the first and currently the only passive fund in the country which offers the advantage of investing in microcap stocks. Passive funds are like a shadow of an index in the stock market. The main objective of passive funds is to generate returns equal to their benchmark index. Whereas active funds try to beat the returns of the index.

According to NSE, Motilal Oswal Nifty MicroCap 250 Index Fund is a fund that copies Nifty MicroCap 250 Index
Microcap stocks follow the Nifty 500 stocks, ie the top 250 stocks below them. According to the average total market cap, these stocks are ranked from 501 to 750. Currently, only 4% of the total assets under management of the mutual fund industry is invested in microcap stocks while 55% is invested in largecap stocks, 23% in midcaps and 15% in smallcaps.

Returns and Risk
Compared to large cap companies, micro cap stocks fluctuate a lot. This is due to the problem of high liquidity. It also affects the returns of the investors. Low liquidity, limited analyst coverage and weakness in the market can prove to be several negative factors for this type of fund. Investing in microcap companies also requires thorough research and risk management by fund managers.

Market cap of microcap companies is less than Rs 10,000 crore. If we talk about the returns in Nifty Microcap 250 index, then as of July 20, 2023, it has given 41% returns in one year, 20% in three years and 12% in five years. Which means, a leopard-like race can be expected from such funds.

What is the expense ratio?
For Motilal Oswal Nifty Microcap 250 Index Fund Direct Plan the Total Expense Ratio is 0.40% p.a. Similarly, for the regular plan, its expense ratio is 1% per annum. Also, if you redeem the units within 15 days, then one percent exit load will be imposed. Also the tax on this fund is similar to that of an equity mutual fund.

Who should invest, who should stay away?
SEBI or AMFI have not yet created a separate equity category for microcap funds. Experts recommend only those investors to invest in these funds who can tolerate high risk and high volatility in such funds.
Mohit Gang, Co-Founder and CEO of Moneyfront says that these stocks have very limited liquidity and are highly volatile. Therefore only experienced investors should invest in such passive funds, who can tolerate sharp price movements and have an investment horizon of more than 10 years. Also, its share in an individual’s aggressive equity portfolio should not be more than 5 to 10 percent.

But still if you are planning to invest in this type of fund, then just wait for its performance as this concept is still in its early stage. Once you see their return pattern you should consider investing. Keep in mind that you invest only a small part of your total portfolio in such funds. If you do not understand that how much is your risk appetite and return requirement then definitely take the help of a financial planner. Also, wait for some new funds to join this race and for SEBI to create an official category for microcap funds.