Motilal Oswal microcap fund is for ‘evolved investors’ who can hold on through highs and lows

• Motilal Oswal Nifty Microcap 250 Index Fund has launched an open-ended passive fund that replicates or tracks the total returns of Nifty Microcap 250 Index.
  
• Investors into micro cap stocks and funds need to be able to withstand declines and hold on to them, say experts.
  
• The new fund offer opened on June 15 and will close on June 29.
  

It’s the secret behind the wealth of the world’s best investors. Some of the greatest investors of all times have made money by identifying stocks early in the day. Undoubtedly micro cap stocks are risky but they also have the ability to generate disproportionate returns over a longer period of time.

Call it discovering the diamonds in the rough if you will – but there is no doubt that the smallest of small companies have the potential to become big. Remember the initial public offering of Infosys back in the day?

Now, asset management company Motilal Oswal is intending to package the secret sauce into a mutual fund for retail investors that invests in the micro cap index. Motilal Oswal Nifty Microcap 250 Index Fund — an open-ended passive fund replicates or tracks the total returns of Nifty Microcap 250 Index.

Microcaps – a high stakes game

Microcaps, as the best investors, have reiterated again and again, is a high stakes game of win and lose. They hold the potential to add value over a long time, but can also be wealth destroyers.

A macroeconomic trigger might slash a large cap company’s value by 10%, but a microcap might end up losing half or more of its value. Apart from multiple regulatory issues that dog companies in this arena, they are also extremely volatile to rumours.

“Micro cap stocks are the first to fall and the last to come back. Investing in them requires a great deal of selectivity. Moreso, investors need to be able to withstand declines and hold on to them,” explains Dhirendra Kumar, CEO of Value Research.

Traditionally, mostly high-networth individuals or HNIs – those who can take hard knocks, are the right people to invest in it. Kumar is unsure if an index is the right way to go about it. The AMC however believes that a passive fund that tracks the index is a better way to manage the volatility in these stocks.

“Since the fund invests in 250 companies, when a company goes bad or bust, the specific risk averages out,” said Mahavir Kaswa, head of research - passive funds, Motilal Oswal AMC.

Who should choose the fund?

Even with ‘averaged out risk’, the fund like the companies is a risky bet. The AMC itself advises investors to put in only a part of their investment into the fund.

“Microcaps have a compelling track record of delivering higher returns compared to its counterparts, albeit at a higher risk. Investors are encouraged to consult their financial advisors, a prudent allocation of 5-10% to this fund may help enhance overall portfolio returns,” said Pratik Oswal, head of passive funds at Motilal Oswal AMC.

Kaswa also adds that it’s a good fund for those who can make technical calls and hold on to the long term.

However, a lot of investors keen on speculation might take an interest in this fund. “Investors’ favourite pastime is to invest based on past performance. Going by that, there will be a lot of investors in this fund,” says Kumar.

But the right kind of investors are those who are able to hold on to a stock, even when their call proved wrong, for at least five years. “They should make a small allocation and be prepared not to sell on big declines and not jump for handsome gains,” Kumar says.

In the first five months of 2023, the funds that are flowing into small and mid cap funds have been growing progressively. As per a report by IDBI Capital, in May, large cap funds saw outflows to the tune of ₹1,362 crore, mid caps saw inflows to the tune of ₹1,196 crore and small cap funds saw inflows to the tune of ₹3,283 crore.

Nifty Microcrap 250 returns and volatility


Source: Motilal Oswal

An AMC into microcaps

The move to go in for a microcap fund is also an ambitious move for Motilal Oswal. The AMC claims that this fund is a natural extension of its Motilal Oswal Nifty 500 Index Fund, complementing its range of broad-based index funds.

The AMC is also hoping to discover the next-big money makers. It’s an unlikely move since mutual funds get into even small caps late into the game generally, and tend to concentrate on larger companies. In fact, less than 4% of the mutual fund industry’s assets under management (AUM) is invested beyond top 500 companies.

Microcaps also often fly under the radar of research analysts, with more than 40% of companies receiving no analyst coverage. Only 12% of microcap stocks have more than five analysts covering them. But Motilal sees it as a positive.

“This creates a higher likelihood of finding hidden opportunities,” it claims in its press release. Kumar however believes that this fund is a way for the AMC to gain attention, as its actively managed funds have not performed very well.

“It’s their way of doing something very novel or interesting,” Kumar says. The expense ratio of the fund is 1% for regular, and 0.40% for direct. The minimum application amount is ₹500 and in multiples of ₹1 thereafter. The new fund offer period commenced on June 15 and closes on June 29.