Close on the heels of Motilal Oswal AMC, Bandhan Mutual Fund is also attempting to enter the thriving micro-cap space. Last week, Bandhan Mutual Fund filed initial papers to launch the Bandhan Microcap Fund. The investment objective is to provide long-term capital appreciation by predominantly investing in equity and equity-related instruments of micro-cap companies.

This appears to be an actively managed micro-cap fund, in contrast to Motilal Oswal AMC’s June 2023 offering, ‘Motilal Oswal Nifty Microcap 250 Index Fund,’ which was the first to target micro-caps but through a passive route. The benchmark for these schemes is the Nifty Microcap 250 Total Return Index.

Microcap 250 Index

The Nifty Microcap 250 Index includes the top 250 companies beyond the Nifty 500 index constituents, selected based on their average full market capitalisation. A stock’s weight is determined by its free-float market capitalisation. According to NSE, micro-cap stocks — broadly defined as stocks with market capitalisation smaller than those of small-cap stocks — have unfortunately not received equal market attention and are not tracked by any popular index.

The Nifty 250 Micro-cap index has market capitalisation ranging from ₹13,240 crore (Ircon International) to as low as ₹1,120 crore (Manali Petrochemicals). Top weighted stocks are Religare Enterprises, Karnataka Bank, Ramkrishna Forgings, Ujjivan Financial Services, Usha Martin and Reliance Power.

The index has shown exceptional performance in the past year. In the last year (according to NSE’s August fact-sheet), the index’s price index yielded a return of 48.67 per cent, while the Total Return Index (TRI) variant of the index returned 49.52 per cent. In comparison, Nifty50 returned 8.42 per cent and 9.53 per cent respectively, and Nifty 500 produced 10.44 per cent and 11.42 per cent, respectively.

The returns of the Nifty Small-Cap index at 28.49 per cent and 29.44 per cent also appear modest compared with the stunning gains given by the micro-cap indices.

Riding on this wave, the Motilal Oswal micro-cap index fund has delivered a point-to-point return of 18.3 per cent since its launch in June. The NAV (Net Asset Value), in fact, reached a high of ₹12.31 last week. It manages assets worth ₹324.357 crore as at August end.

Risks Galore

However, for investors who believe that micro-cap funds are easy money-making instruments, they need to be aware of the risks associated with these funds. Equity investments always carry high risk, but delving into micro-caps is even riskier and more challenging.

Here are some important risk factors outlined by fund houses that investors should keep in mind. Micro-cap stocks are volatile and prone to daily price fluctuations due to both micro and macro factors.  Trading volumes, settlement periods, and transfer procedures may restrict the liquidity of these investments. 

Different segments of financial markets have different settlement periods, which may be significantly extended by unforeseen circumstances. The scheme(s)‘ inability to make intended securities purchases due to settlement problems could cause the scheme(s) to miss certain investment opportunities. 

Moreover, those who wish to do SIP (Systematic Investment Plan) on these schemes while maintaining a long-term investment horizon, should know that AMCs may halt SIPs altogether providing a higher downside risk.

In the short term, these high-beta stocks are prone to considerable volatility. This means that during a bull phase, they will yield strong returns, but in a bear phase, they can dip to new lows and become illiquid.

So, should one avoid these schemes altogether? No. Like small-cap funds that have garnered interest, these schemes will also gain prominence among investors. One can expect more fund houses to join the bandwagon sooner rather than later.

Depending on an investor’s risk appetite, a small allocation to these schemes can indeed enhance returns, potentially helping investors reach their financial goals faster.