Your Questions Answered: What is Nifty Microcap 250 index and how is it different from Nifty 50?

Q. I am a small business owner running an interior decoration business in my hometown. My wife is a housewife. We have been investing in the large-cap sector, in mutual funds tracking Nifty 50 and Sensex, we now want to diversify our investment and invest in other market segments that can offer higher returns. Many of our acquaintances have suggested investing in Nifty Microcap 250 index, can you please elaborate on it, its pros and cons, and how it is different from Nifty 50?

Dileep Jain, Udaipur, Rajasthan

Mutual funds that track the Nifty Microcap 250 index offer retail investors a unique opportunity to invest in the potential growth of small companies in India. These mutual funds aim to replicate the performance of the Nifty Microcap 250 index, which consists of 250 micro-cap companies listed on the National Stock Exchange (NSE).

Understanding the index composition

The Nifty Microcap 250 index is composed of 250 micro-cap companies listed on the NSE. This index excludes large-cap and mid-cap companies, and even the top 250 small-cap companies (based on market capitalisation) are excluded.

Essentially, the index consists of companies that are outside of the top 500 companies listed on the NSE in terms of market capitalisation. The selection criteria ensures that these are actively traded companies with reasonable liquidity to facilitate investment and trading by investors.

Performance and volatility

Historically, micro-cap stocks have been more volatile than their larger peers. This volatility can be attributed to various factors including lower liquidity, less analyst coverage, and higher sensitivity to market sentiment.

However, this volatility also presents opportunities for higher returns, especially for investors who have a high-risk tolerance and a long-term investment horizon. Over the last year, the Nifty Microcap 250 has given a total return of 72.68% (as of 31st July 2024) whilst the Nifty 50 has given a total return of 27.84% (as of 31st July 2024).

Advantages of investing in Nifty Microcap 250 index

Diversification: Mutual funds that track the Nifty Microcap 250 index provide exposure to a wide range of micro-cap companies, which are typically the 501st to 750th largest companies listed on the NSE of India in terms of market capitalisation. This diversification can help spread risk across many different sectors and stocks.

Growth potential: Micro-cap companies often have the potential for high growth, which can translate into significant returns for investors. By investing in a mutual fund tracking the Nifty Microcap 250 index, investors can participate in the growth stories of these smaller companies that may not be as well-known or accessible otherwise.

Professional management: Investors benefit from professional fund management when they invest in mutual funds. Fund managers are responsible for tracking the index and making investment decisions, which can be particularly beneficial for investors who may not have the time or expertise to manage their investments.

Low cost: Index funds, including those tracking the Nifty Microcap 250, are known for their low expense ratios compared to actively managed funds. This is because they are designed to replicate the performance of the index, which typically requires less active trading and management.

Liquidity: Mutual funds offer liquidity, allowing investors to buy or sell their fund units on any business day. This provides flexibility and access to funds when needed.

Systematic investment and withdrawal: Investors can take advantage of systematic investment plans (SIPs) and systematic withdrawal plans (SWPs) with mutual funds, enabling them to invest or withdraw funds at regular intervals.

Transparency: Mutual funds are regulated and offer transparency in terms of holdings, performance, and costs. Investors can easily track the performance of their investments and the underlying assets.

Disadvantages of investing in Nifty Microcap 250 index

Market risk: Microcap stocks can be more volatile and riskier than large-cap stocks, potentially leading to higher losses during market downturns.

Vulnerability: While small-cap stocks can offer significant growth potential, they are more vulnerable to macroeconomic challenges such as high interest rates.

Liquidity concerns: Microcap stocks may have lower liquidity, which can result in higher bid-ask spreads and difficulty in buying or selling shares without impacting the market price.

Differences between Nifty Microcap 250 and Nifty 50

The Nifty Microcap 250 index and the Nifty 50 are two distinct indices on the NSE, representing different segments of the market. Understanding these differences is crucial for investors when making informed decisions about where to allocate their capital within the Indian stock market. We have mentioned the key differences between the two indices below:

Market capitalisation and company size: The Nifty 50 index is composed of the top 50 large-cap companies in India, which are well-established with a solid track record of performance and stability. These companies are leaders in their respective industries and have a significant impact on the market movements.

In contrast, the Nifty Microcap 250 index focuses on micro-cap companies, which are much smaller in terms of market capitalisation. These companies are often in the early stages of development and can offer high growth potential, but they also come with higher risks and volatility.

Sector exposure: The Nifty 50 provides broad exposure to various sectors of the Indian economy, including IT, financial services, energy, consumer goods, and healthcare. This makes it a representative index of the Indian market’s overall performance. The Nifty Microcap 250, however, may have a different sectoral composition, with a higher representation of industrial, materials, and small-scale consumer companies. This difference in sector exposure can lead to varying performance patterns between the two indices.

Liquidity: Stocks in the Nifty 50 index are highly liquid, meaning they can be bought and sold in large volumes without significantly affecting the share price. This liquidity is due to the large market capitalisation and the high level of investor interest in these stocks. On the other hand, stocks in the Nifty Microcap 250 index are less liquid, which can result in higher bid-ask spreads and potentially more significant price impact from trade executions.

Investment horizon and risk profile: The Nifty 50 is often preferred by investors with a long-term investment horizon who seek stability and steady growth. These investors are typically risk-averse and prefer the predictable nature of large-cap stocks. Conversely, the Nifty Microcap 250 may attract investors with a higher risk tolerance, looking for short-term gains and willing to invest in companies with the potential for exponential growth. However, these investments carry a higher risk of loss.

Performance expectations: Historically, large-cap indices like the Nifty 50 tend to have more stable returns over time, with less dramatic swings in performance. Micro-cap indices, such as the Nifty Microcap 250, can experience significant fluctuations, with the potential for both substantial gains and losses. This volatility is a result of the smaller size and lower liquidity of micro-cap stocks, as well as their sensitivity to market sentiment and economic factors.

Index construction and maintenance: The Nifty 50 is a well-established index with a fixed number of constituents, and changes to the index composition are relatively infrequent. The selection criteria for inclusion are stringent, focusing on liquidity and market capitalisation. The Nifty Microcap 250, however, has a more dynamic composition, and changes to the index constitution are more frequent. The selection is based on full market capitalisation, and a buffer is used to reduce portfolio churn.

Who should invest in mutual funds tracking Nifty Microcap 250 index?

Before investing, it’s crucial to understand the fund’s objective, the track record of the fund house, the expense ratio, and how it fits into your overall investment strategy. It’s also important to note that while micro-cap stocks can offer significant growth potential, they also come with higher volatility and risk.

Investing in micro-cap stocks requires careful consideration of risks. These companies often have less established track records, may face higher operational risks, and can be more susceptible to market downturns. It’s crucial for investors to conduct thorough due diligence and consider diversification to mitigate these risks. Investors should consider their risk tolerance and investment horizon before choosing to invest in mutual funds tracking the Nifty Microcap 250 index. It’s advisable to consult with a financial advisor to ensure that this investment aligns with your financial goals and objectives.

Taxation of Nifty Microcap 250 index mutual funds

The taxation of Nifty Microcap 250 mutual funds is similar to that of other equity mutual funds in India. The gains from these funds are classified into two categories:

Short-term capital gains: If the units of the Nifty 50 index mutual fund are sold within one year of purchase, the gains are considered STCG. These gains are taxed at a flat rate of 20% after the Budget 2024.

Long-term capital gains: For units sold after one year from the date of purchase, the gains are classified as LTCG. The tax rate for LTCG is 12.5% on gains exceeding Rupees1.25 lakh in a financial year. It’s important to note that there is no indexation benefit available for LTCG on equity mutual funds.

Factors influencing tax liability

Several factors can influence the tax liability from an investment in Nifty Microcap 250 index mutual funds:

Holding period: As mentioned, the duration for which the investment is held significantly affects the tax rate.

Income bracket: The investor’s income bracket does not influence the tax rate for STCG or LTCG, as these are flat rates.

Type of returns: Dividends received from the mutual fund are also taxable in the hands of the investor as per the individual’s income tax slab rates.

Tax planning is an integral part of investing, and understanding the taxation rules applicable to Nifty 250 Microcap index mutual funds can help investors make more informed decisions. It’s always recommended to consult with a tax advisor to understand the nuances of taxation and how it applies to individual circumstances.

Conclusion

The Nifty Microcap 250 index offers a window into the dynamic world of micro-cap investing in India. While it comes with its set of challenges and risks, it also holds the potential for significant returns for informed investors who understand the nuances of this market segment.

Investing in a mutual fund tracking the Nifty Microcap 250 index allows for diversification, as it spreads the investment across various sectors and reduces the risk associated with individual stocks. Moreover, these funds are managed by professional fund managers who are adept at navigating the volatile small-cap market.

Kuvera is a free direct mutual fund investing platform. Unless otherwise stated data sourced from BSE, NSE and kuvera