Your Questions Answered: What is the Nifty Microcap 250 index, and how does it differ from the Nifty 50?

Q: I am a small business owner running an interior decoration business, and my wife is a housewife. We have been investing in large-cap sectors through mutual funds tracking Nifty 50 and Sensex. We are now considering diversifying our investments into other market segments that might offer higher returns. Some acquaintances have suggested investing in the Nifty Microcap 250 index. Could you elaborate on this index, its advantages and disadvantages, and how it differs from the Nifty 50?

Dileep Jain, Udaipur, Rajasthan

The Nifty Microcap 250 index provides a unique investment opportunity by focusing on small companies listed on the National Stock Exchange (NSE). This index includes 250 micro-cap companies, which are smaller in market capitalization compared to the top 500 listed companies.

Understanding the Nifty Microcap 250 Index

The Nifty Microcap 250 index consists of companies outside the top 500 by market capitalization on the NSE. These are actively traded micro-cap stocks with reasonable liquidity, excluding large-cap and mid-cap companies.

Performance and Volatility

Micro-cap stocks are generally more volatile than large-cap stocks. This volatility can result in higher returns, particularly for investors with a high-risk tolerance and a long-term perspective. Over the past year, the Nifty Microcap 250 has returned 72.68% as of July 31, 2024, compared to 27.84% for the Nifty 50.

Advantages of Investing in the Nifty Microcap 250 Index

1. Diversification: Investing in this index provides exposure to a wide range of micro-cap companies, helping spread risk across various sectors.
2. Growth Potential: Micro-cap companies often have significant growth potential, which can lead to substantial returns.
3. Professional Management: Mutual funds tracking this index are managed by professionals, offering investment expertise and convenience.
4. Low Cost: Index funds generally have lower expense ratios compared to actively managed funds due to their passive management approach.
5. Liquidity: Mutual funds offer liquidity, allowing for regular buying and selling of units.
6. Transparency: Mutual funds are regulated and offer clear information on holdings, performance, and costs.

Disadvantages of Investing in the Nifty Microcap 250 Index

1. Market Risk: Micro-cap stocks are more volatile and can experience significant losses during market downturns.
2. Vulnerability: These stocks may be more affected by macroeconomic challenges, such as high interest rates.
3. Liquidity Concerns: Micro-cap stocks may have lower liquidity, leading to higher bid-ask spreads and potential difficulties in trading.

Differences Between Nifty Microcap 250 and Nifty 50

1. Market Capitalization and Company Size: The Nifty 50 comprises the top 50 large-cap companies with established performance and stability, while the Nifty Microcap 250 focuses on smaller, less established companies with higher growth potential but also higher risks.
2. Sector Exposure: The Nifty 50 offers broad sector exposure, whereas the Nifty Microcap 250 may have a different sectoral composition with a higher representation of small-scale industries.
3. Liquidity: Stocks in the Nifty 50 are highly liquid, whereas micro-cap stocks are less liquid, potentially impacting the ease of buying or selling.
4. Investment Horizon and Risk Profile: The Nifty 50 is suited for risk-averse investors seeking stability, while the Nifty Microcap 250 appeals to those with a higher risk tolerance seeking higher growth.

Who Should Invest in the Nifty Microcap 250 Index?

Investors considering this index should be aware of its higher volatility and risks. It is suitable for those with a long-term investment horizon and a high risk tolerance. It’s advisable to consult with a financial advisor to ensure this investment aligns with your financial goals and risk profile.

Taxation of Nifty Microcap 250 Index Mutual Funds

• Short-term Capital Gains (STCG): Gains from units sold within one year are taxed at 20%.
• Long-term Capital Gains (LTCG): Gains from units sold after one year are taxed at 12.5% on amounts exceeding ₹1.25 lakh per financial year. There is no indexation benefit available for LTCG on equity mutual funds.

Conclusion

Investing in the Nifty Microcap 250 index offers potential high returns but comes with increased risks and volatility. Diversification, professional management, and low costs are key benefits, while market risk and liquidity concerns are notable disadvantages. Investors should evaluate their risk tolerance and investment goals before proceeding and consider consulting a financial advisor for tailored advice.