The new Nifty Microcap 250 index: Is it suitable for retail investors?

There is a new index in town – the Nifty Microcap 250. As the name suggests, it aims to track the performance of microcap stocks listed on the NSE, which is an extremely risky set.

But these are the top 250 companies ‘beyond’ the Nifty 500 index companies. That is, the Nifty Microcap 250 index is made up of micro-cap companies ranked from 501 to 750, based on of their average full market capitalization.

Tracking tiny stocks

Please understand that in the hierarchy of market caps, this index comes after large-cap, mid-cap and small-cap. Backtesting (as per NSE’s website) suggests that since inception, the index has delivered a total annual return of 16 percent.

So this index finally provides a benchmark to track the performance of stocks below the Nifty 500. For investors who invest in small and micro-cap stocks directly, this is a welcome development.

But for the  regular small investor, how useful is this new index?

I think they can skip this index. That might seem like a strong statement to make, but here is the argument. And let me first tell you a bit about the small-cap space first.

Many uninformed investors believe that small-cap funds can always deliver higher returns than other equity schemes. But that isn’t true. These small- cap funds may give supernormal returns for a year or two, but would later take a backseat. These funds might do very well in rising markets. But they also get hit very hard during downturns. The return fluctuations are quite large in these funds. You may have to wait for a really long time to see good returns from small-cap schemes if you enter at the wrong time. And since micro-caps are far riskier than small-caps, I am sure you get the hint on why they are not worth your time.

Many micro-cap companies are extremely cyclical and prone to different risks. And given the quality of financial reporting in India, you can’t actually take the results of these companies without a pinch of salt. Occasionally, some micro-caps will show diamond-like brilliance. And some smart market operators will try to pump it up to make profits. But brilliance can suddenly turn into darkness for small companies. Profits and revenues can fall off a cliff in a jiffy. A large or mid-sized company has the financial depth to make comebacks. But most micro-cap companies don’t. And that is the biggest challenge of this space. A small company may never recover from what seems like a temporary issue.

Too risky for small investors

For the financial well-being of small investors, AMCs (asset management companies) should never launch any active or passive funds tracking this microcap index. The space is extremely risky and not suitable for small investors who are better off with a bulk of their investments parked in large-cap index, flexi-cap, large & mid-cap and mid-cap funds.

And let alone the micro-cap space, I think that even the small-cap funds are best avoided by most investors. I have maintained this view for a long time and written about it earlier while discussing investment products to avoid.

It’s not that investing in small or micro-cap stocks cannot be profitable. After all, those are the spaces where most of the so-called multi-baggers are born. But it’s also true that they are extremely risky. And micro-caps far more than the small-caps. Experts and professional investors are better off investing in such stocks.

It is quite possible that, in the near future, some AMC may come out with an index or active fund tracking the Nifty Microcap 250 to bring in some fresh AUM and make easy money with high expense ratios. If and when that happens, just ignore those NFOs for your own good.