There is another new fund offer on the block — an index fund that seeks to invest in the small-cap universe. The Nippon India Nifty Smallcap 250 Index Fund will invest in companies that are part of the Nifty Smallcap 250 index. The issue is open from September 28 to October 9.

The scheme will track the Nifty Smallcap 250 total return index and invest 95-100 per cent of its corpus in stocks making up the Nifty Smallcap 250 index and up to 5 per cent in debt securities.

As the total expense ratio on index funds are considerably lower than that of actively managed funds, Nippon India Nifty Smallcap 250 Index Fund offers investors a cheaper way to invest in small-cap stocks.

The Nifty Smallcap 250 TRI has registered returns of -0.4 per cent, -7.1 per cent and 4.4 per cent over a one-, three- and five-year periods, respectively.

Investment universe

The Nifty Smallcap 250’s stock universe consists of companies across various sectors such as consumer durables and non-durables, finance, pharmaceuticals, software, industrial products, industrial capital goods, and construction.

In terms of sectoral weight on the Nifty Smallcap 250 index, the top five sectors are consumer non-durables (8.8 per cent), industrial products (8.4 per cent), finance (7.7 per cent), chemicals (7.3 per cent) and pharmaceuticals (6.2 per cent).

Out of the 250 companies whose shares will form part of Nippon India Nifty Smallcap 250 Index Fund, only 138 companies had a return on equity of above 10 per cent in 2019-20. This number was 161 in 2018-19, 157 in 2017-18, and 146 in 2016-17 and 2015-16.

Although this is past data, it points to a limited pool of companies from the Nifty Smallcap 250 index that can give reasonable returns to investors.

Small-cap funds performance

In the past one year, the Nifty Smallcap 250 TRI has posted returns of -0.4 per cent. The top five actively managed small-cap funds (in terms of returns) — Quant Small Cap, SBI Small Cap, Axis Small Cap, Kotak Small Cap and even Nippon India’s own Small Cap Fund — have outperformed the index handsomely in the past year. Even in three- and five-year time periods, these funds have outperformed the Nifty Smallcap 250 TRI.

Our take

If your are looking for an MF that invests in the small-cap universe, Nippon India Nifty Smallcap 250 Index Fund presents a low-cost opportunity. The expense ratio of peer Motilal Oswal Nifty SmallCap 250 Index Fund is -0.9 per cent. Actively managed small-cap funds have an expense ratio of 1.8-2.2 per cent.

Secondly, small-cap stocks are volatile and many of them may not have adequate liquidity in the market as they are not frequently traded. Investing in a index fund takes away that risk for an investor.

However, if one goes by past performance of actively managed small-cap mutual fund schemes, stock selection by fund managers does help generate returns higher than the benchmark indices.