There are plans to launch other micro-cap funds: Invest or stay away? Just Save

 There are plans to launch other micro-cap funds: Invest or stay away? Just Save

The potential advantages of investing in micro-cap stocks are worth considering, but there are a number of risks involved as well. Head of Research at Fisdom Nirav Karkera discusses what the micro-cap valuations suggest as well as how funds might control risk in micro-cap funds. Take note.

Investors and mutual fund companies have taken an interest in the smallest market-cap pack as a result of the surge in micro-cap firms over the past year.

In all mutual fund schemes, the value of micro-cap stocks has increased from Rs 45,500 crore in September of previous year to above Rs 60,000 crore at this time.

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What are micro-caps, though, first?

Small-caps are the cohort of firms with a complete market capitalization after 251st company, while large-caps are defined as the 1st to 100th companies and mid-caps as the 101st to 250th companies. A corporation is categorized as a micro-cap if it is not among the top 500.

The micro-cap pack has recently outperformed other market caps in terms of returns. The Nifty 100 Total Return Index (TRI) has increased by 10% during the past year. Nifty Micro-Cap 250 TRI is up 44% and Nifty Small-Cap 250 TRI is up 28% in comparison to this.

Even fund houses are considering placing bets on this rise after such performance.

Motilal Oswal Mutual Fund introduced India's first passive program that provides exposure to micro-cap equities in June of this year. Now, Bandhan Mutual Fund is attempting to introduce the country's first active equity investment program.

Also Read | Buying mutual funds has never been simpler: Only a Visa debit card is required.

Nirav Karkera, Head of Research at Fisdom, was interviewed by Moneycontrol to discuss what micro-cap valuations are telling us, whether fund houses are taking on additional risk by investing widely in market caps, and how funds may manage the risks in micro-cap funds.

The following is a precis of what Karkera said:

Micro-caps offer great potential for wealth development, but they can also be a value trap. The majority of these businesses lack adequate research. To those who are ready to put in the extra effort, the micro-cap market presents enormous prospects. Do your study and select very sound businesses.

The micro-cap market's valuation may currently appear to be excessive. However, it is important to realize that for micro-caps, conventional ratios might not be relevant. Capital goods and financial services account for approximately a third of the weighting in the micro-cap 250 index. The valuations of the entire index may reflect enthusiasm as a result of these sectors. This does not, however, apply uniformly to all micro-caps.

In the micro-cap space, the survival rate is extremely low. These businesses have smaller market caps and more fragile balance sheets than their bigger competitors. Additionally, their capacity to withstand Black Swan occurrences and macroeconomic headwinds is quite constrained.

Over longer periods, micro-caps have beaten the majority of their market-cap rivals, but one feature that is also highly unique is that these stocks have extremely severe drawdowns and operate in a wide range of volatility.

For a very long time, there was a lot of value in the large-cap, mid-cap, and small-cap categories that had yet to be realized. There are currently little chances in these categories. As a result, in their attempt to find riskier but potentially more lucrative bets, mutual funds are increasingly willing to delve deeper and farther into the micro-cap segment.

It would be inaccurate to claim that investing in micro-cap companies by mutual funds involves increased risk. Fund companies provide the knowledge infrastructure and analytic and research capabilities needed to make wise investment decisions. Although there is a chance that this market's volatility will be higher than its larger competitors', this does not necessarily mean that the risk will also be higher.

Lack of liquidity is a major issue in this market, and the potential of higher impact costs is greatly increased. A passive fund can get around the majority of these obstacles. The lack of liquidity in the micro-cap market may force an active fund to operate with a very long tail, which requires diversifying across an increasing number of companies.

A retail investor can invest in micro-cap funds if they have a seven to ten-year investment horizon. Retail investors don't need to avoid micro-caps, but they do need to be prudent when allocating funds to micro-cap funds.