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Exploring the Nifty Microcap 250 Index for Investors: A Guide to Diversifying Your Portfolio

1.      Introduction

In the ever-evolving landscape of India’s capital markets, where companies continually seek to raise capital and investors strive to identify opportunities for growth, the National Stock Exchange (“NSE”) has played a pivotal role. Over time, the NSE has witnessed a remarkable expansion in its roster of listed companies, reflecting the deepening of India’s capital markets and the growing trend of companies going public. Amid this dynamic environment, a distinct category of stocks often overlooked by traditional market classifications has emerged – Microcap stocks. In this article, we analyze the category of Microcap stocks on the NSE, exploring the Nifty Microcap 250 Index, its key features, and its remarkable growth. We will also examine the pros and cons of investing in mutual funds tracking this index, offering you insights into this newer segment of India’s stock market to diversify your portfolio.

2.      Expanding Nifty Beyond The Traditional Three Classifications

The NSE’s roster of listed stocks has significantly expanded over time, reflecting the deepening of capital markets and an increasing number of companies going public. As of June 30, 2021, more than 1600 companies found their place on the NSE Main Board, starkly contrasting to approximately 900 firms in 2006.[1] These listed stocks have typically been categorized based on their market capitalization into Large cap, Mid cap, Small cap, and Micro cap.

The trio of Large cap, Mid cap, and Small cap stocks has consistently garnered the attention of market participants and stock analysts. These segments have also been represented by various equity indices, offering insights into their performance throughout market cycles. For instance, Nifty 100 caters to the large-cap segment,[2] Nifty Midcap 150 focuses on mid-cap stocks,[3] and Nifty Smallcap 250 encompasses the small-cap realm.[4] The Nifty 500, on the other hand, encapsulates all three segments under one index.[5]

Unfortunately, Micro cap stocks, which are characterized by smaller market capitalizations compared to Small cap stocks, have not received the same level of market attention. They remain absent from widely tracked indices. Microcap companies, those beyond the Nifty 500 constituents, play a crucial role in economic growth and job creation but often lack the representation accorded to larger companies.

For instance, sectors like Financial Services and IT, pivotal to economic development, enjoy substantial representation in the Nifty 500 with significant weights. Conversely, sectors like Industrial Manufacturing and Chemicals, equally vital for the economy, have limited presence in the large, mid, or small-cap indices due to their smaller sizes. In the Nifty 500 Index, the Industrial Manufacturing and Chemicals sectors comprise only around 3% and 2%, respectively.

Addressing this gap, the NSE introduced the Nifty Microcap 250 Index. This index offers investors a tool to monitor the less-represented microcap segment, extending beyond the established Large, Mid, and Small cap categories. Importantly, the Nifty Microcap 250 Index notably adjusts the sector weights, with the Industrial Manufacturing and Chemicals sectors accounting for approximately 14% and 6%, respectively, compared to their lower representation in the Nifty 500 Index. In essence, the Nifty Microcap 250 Index provides a more balanced sector distribution and bridges the existing research gap, delivering valuable insights into the performance of microcap stocks across different timeframes.

3.      What is the Nifty Microcap 250 Index?

The Nifty Microcap 250 Index[6] is a market capitalization-weighted index that operates under the free-float methodology. It is designed to monitor the performance of 250 microcap companies listed on the NSE, excluding the top 500 companies listed on the NSE. Essentially, this index consists of companies ranked from 501st to 750th in terms of market capitalization.

The term ‘Microcap’ lacks an official definition within SEBI regulations. However, for the purposes of this explanation, we consider companies falling within the 501st to 750th range in market capitalization as Microcap.

The Nifty Microcap 250 Index undergoes a semi-annual review, employing a fast-entry, fast-exit approach. This means that companies are either added to or removed from the index based on their market capitalization as of the final trading day of March and September each year.

This index holds significant relevance in the financial landscape, serving as a popular benchmark for investors seeking to monitor the performance of the microcap segment within the Indian stock market. Additionally, fund managers often use it as a benchmark to assess the performance of their microcap funds.

3.1.   Key Features Of The Nifty Microcap 250 Index[7]

·         The Nifty Microcap 250 Index was established with a base date of April 01, 2005, and a starting value of 1000. It consists of the top 250 companies that fall beyond the scope of the Nifty 500 index constituents. These companies are selected based on their average full market capitalization.

·         The index calculates the weight of each stock by considering its free-float market capitalization. A buffer tied to full market capitalization is applied to minimize excessive portfolio turnover.

·         Semi-annual reviews are conducted to ensure the index remains current and relevant. It employs a fast-entry, fast-exit mechanism during these reviews.

·         Being a free-float market capitalization-weighted index, it maintains proportionality in stock weightings relative to their market capitalization. This design guarantees that the index accurately represents the broader microcap segment of the Indian stock market.

·         This diligent review process, conducted semi-annually, ensures that the Nifty Microcap 250 Index continually tracks the top 250 microcap companies listed on the NSE, offering an up-to-date perspective on this market segment.

3.2.   Key Highlights Of The Nifty Microcap 250 Index’s Impressive Growth[8]

·         From April 01, 2005, to June 30, 2021, the Nifty Microcap 250 Index delivered an annual return of 16.2%, surpassing the 15.5% annual return of the Nifty Smallcap 250 Index.

·         Overextended timeframes, the Nifty Microcap 250 Index consistently outperformed the Nifty Smallcap 250 Index on a rolling return basis. Using daily return data, it outperformed the Nifty Smallcap 250 Index in 64.8% and 81.9% of instances for rolling returns calculated over 7-year and 10-year periods.

·         The Nifty Microcap 250 Index boasts a Herfindahl-Hirschman Index (“HHI”) value of 816.1, closely aligned with the Nifty Smallcap 250 Index’s HHI value of 804.0. This similarity suggests a comparable level of diversification between the two indices. Interestingly, the Nifty Microcap 250 Index demonstrates greater diversification than the Nifty 500 Index, which carries an HHI value of 1489.8.

3.3.   Top 10 Constituents Of The Nifty Microcap 250 Index

The top 10 constituents out of 250 from the Nifty Microcap 250 Index include (in a hierarchical order):[9]

1.      Religare Enterprises Ltd.

2.      Karnataka Bank Ltd.

3.      Ramkrishna Forgings Ltd.

4.      Ujjivan Financial Services Ltd.

5.      Usha Martin Ltd.

6.      Reliance Power Ltd.

7.      Himadri Speciality Chemical Ltd.

8.      Titagarh Rail Systems Ltd.

9.      Reliance Infrastructure Ltd.

10.  South Indian Bank Ltd.

3.4.   Index Methodology of the Nifty Microcap 250 Index[10]

3.4.1.      Eligibility Criteria

·         To qualify for inclusion, companies must rank within the top 1000 based on average daily turnover and average daily full market capitalization over the preceding six months.

·         Stocks that are part of, or in the process of being included in, the Nifty 500 are not eligible for inclusion in this index.

3.4.2.      Compulsory Inclusion and Exclusion

·         Stocks falling within the rank range of 351 to 675 based on a six-month average full market capitalization are automatically included.

·         Any stock found to be ineligible based on the aforementioned criteria will be compulsorily excluded.

3.4.3.      Weighting Method

The weight assigned to each stock within the index is determined by its free-float market capitalization.

3.4.4.      Index Re-Balancing

The index undergoes a semi-annual re-balancing process, with cut-off dates falling on January 31 and July 31 each year. This means that for the biannual review of the indices, data from the preceding six months, ending on the cut-off date, is taken into account. The market is notified four weeks in advance of any impending changes.

3.4.5.      Index Governance

A team of professionals manages all NSE indices. The governance structure comprises three tiers: the Board of Directors of NSE Indices Limited, the Index Advisory Committee (Equity), and the Index Maintenance Sub-Committee.

4.      Differentiating Between Large Cap, Smallcap, Midcap And Microcap Categories Of The NSE

In the Indian stock market, stocks are categorized into large-cap, mid-cap, and small-cap based on their market capitalization (market cap), which is the total value of a company’s outstanding shares. Market cap is calculated by multiplying the share price by the total number of shares in circulation.

Large-cap stocks are the cream of the crop, comprising the top 100 companies in India by market cap. These firms are typically well-established and boast a proven track record of profitability. Their shares are highly liquid, meaning they are traded frequently and in substantial volumes. This liquidity makes it convenient for investors to buy and sell large-cap stocks without significantly affecting their prices.

Mid-cap stocks, on the other hand, fall in the range of 101 to 250 in terms of market cap rankings. They are generally smaller and less mature than large-cap companies but offer the potential for rapid growth. While mid-cap stocks can be more volatile compared to large-cap counterparts, they also have the potential to provide higher returns over the long term.

Small-cap stocks comprise companies ranked 251 or lower by market cap. These companies are typically the smallest and least established among the three categories. Small-cap stocks tend to be the most volatile, offering both the potential for substantial gains and the risk of significant losses.

The term ‘Microcap’ lacks an official legal definition under SEBI regulations. However, for the purposes of this article, we consider companies listed on the NSE that fall between the 501st and 750th positions in terms of market capitalization as Microcap.

5.      Assessing the Pros and Cons of Microcap of Nifty 250 Microcap Index

5.1.   Pros of investing in mutual funds tracking Nifty 250 Microcap Index

5.1.1.      Professional Oversight

Skilled fund managers oversee mutual funds, bringing their expertise and track record to the table. They are adept at curating and managing a portfolio of stocks, a valuable advantage for investors who lack the time or knowledge to handle their own investments.

5.1.2.      Diversification

Investing in mutual funds that mirror the Nifty 250 index offers a broad exposure to a diverse array of microcap companies in India. This diversification strategy serves to mitigate risk and enhance long-term returns for investors.

5.1.3.      Cost-Efficiency

Mutual funds represent a cost-effective avenue for participating in the stock market. Index fund expense ratios are typically quite low, ensuring that investors retain a larger portion of their returns.

5.2.   Cons Of Investing In Mutual Funds Tracking Nifty 250 Microcap Index

5.2.1.      Sensitivity To Macroeconomic Shifts

Due to their smaller scale, microcap companies are more sensitive to macroeconomic changes, including shifts in interest rates. Such economic shifts can have a significant impact on these companies.

5.2.2.      Volatility

Microcap stocks tend to exhibit higher volatility compared to their large-cap counterparts. Consequently, investments in microcaps can experience more pronounced price fluctuations.

6.      Due Diligence Checklist for Investing in Mutual Funds Tracking Microcap 250 Index

As highlighted in the pros and cons above, opting for mutual funds that track the Nifty 250 index can serve as a beneficial strategy for gaining exposure to India’s microcap stock segment. Nevertheless, investors should exercise caution due to potential risks, including heightened volatility, limited liquidity, and the availability of comparatively less information about these companies. Furthermore, investors should look out for:

6.1.   Investment Objectives

Investors should align their investment goals with the choice of mutual funds tracking the Nifty 250 index. If the objective is short-term gains and lower volatility, exploring alternative investment avenues that offer a less turbulent ride might be advisable.

6.2.   Investment Horizon

Given the elevated volatility associated with microcap stocks within mutual funds tracking the Nifty 250 index, adopting a long-term investment horizon is crucial. This approach allows investors to weather short-term fluctuations and potentially benefit from the long-term growth potential.

6.3.   Risk Tolerance

Before investing in mutual funds linked to the Nifty 250 index, individuals must carefully assess their risk tolerance. Microcap stocks tend to exhibit higher volatility than their large-cap counterparts, necessitating that investors are comfortable with the possibility of incurring losses.

7.      Conclusion

Microcap stocks are known for their heightened volatility, often surpassing large-cap stocks. Moreover, they tend to exhibit heightened sensitivity to economic downturns. This susceptibility is attributed to the fact that microcap companies typically possess less diversified revenue sources and less robust balance sheets compared to their larger counterparts. Should you contemplate an investment in mutual funds linked to the Nifty 250 index, engaging in thorough research and gaining a comprehensive understanding of the associated risks is imperative. Seeking counsel from a financial advisor is advisable to assess whether this investment aligns with your financial goals and risk tolerance.

[7] Nifty (n.1).

[8] Nifty (n.1).

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