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Best Small Cap Index Mutual Funds in India | Equity Mutual Funds List

Explore Top Small Cap Index Mutual Funds in India in 2024:

Last updated on : 03 Sep 24

What is a Small Cap Index Fund?

A Small Cap Index Fund is a type of mutual fund that aims to replicate the performance of a specific small-cap index, such as the Nifty Smallcap 100 Index. Small-cap companies, which typically rank beyond the top 250 companies listed on major stock exchanges like the NSE and BSE, have a smaller market capitalization compared to mid-cap and large-cap companies. This category of companies is often in the early stages of growth, making them potentially high-reward investments due to their capacity for rapid expansion.

However, the high growth potential of small-cap stocks comes with increased volatility and risk. Unlike large-cap companies, which are more established and have a proven track record, small-cap companies may still be developing their business models, facing higher competition, and having less access to capital. This makes them more susceptible to market fluctuations, economic downturns, and operational challenges.

Best Small Cap Index Funds of 2024

Small Cap Index Mutual Funds continue to be an attractive option for investors seeking exposure to high-growth potential within the small-cap segment.

S No.

Small Cap Index Funds

ISI

AMFI

1

Aditya Birla Sun Life Nifty Smallcap 50 Index Fund

INF209KB1W17

148815

2

Axis Nifty Smallcap 50 Index Fund

INF846K013H3

149894

3

Bandhan Nifty Smallcap 250 Index Fund

INF194KB1HG9

152264

4

DSP Nifty Smallcap 250 Quality 50 Index Fund

INF740KA1TW1

152243

5

Edelweiss Nifty Smallcap 250 Index Fund

INF754K01QT8

150892

6

HDFC NIFTY Smallcap 250 Index Fund

INF179KC1GE4

151727

7

ICICI Prudential Nifty Smallcap 250 Index Fund

INF109KC1V18

149283

8

Kotak Nifty Smallcap 50 Index Fund

INF174KA1NB3

151649

9

Motilal Oswal Nifty Microcap 250 Index Fund

INF247L01BQ9

151814

10

Motilal Oswal Nifty Smallcap 250 Index Fund

INF247L01932

147623

11

Nippon India Nifty Smallcap 250 Index Fund

INF204KB15W0

148519

12

SBI Nifty Smallcap 250 Index Fund

INF200KA16P2

150677

How Do The Best Small Cap Index Funds Work?

  • The best Small Cap Index Funds function through a passive investment strategy, meaning that the fund manager's goal is not to outperform the market but to mirror the performance of the underlying small-cap index as closely as possible. This approach contrasts with actively managed funds, where fund managers actively buy and sell stocks in an attempt to beat the market.

  • Composition and Structure: The fund's portfolio is constructed to include all or a representative sample of the stocks in the small-cap index it tracks. Each stock in the index is included in the fund's portfolio in a proportion that mirrors its weight in the index. For example, if Company A constitutes 2% of the Nifty Smallcap 100 Index, the fund will allocate approximately 2% of its assets to Company A's stock.

  • Performance Replication: The performance of Small Cap Index Funds is highly correlated with the performance of the index it tracks. The goal is to deliver returns that closely match the index, taking into account factors like dividends, stock splits, and changes in the index's composition. However, there may be slight deviations, known as tracking errors, which can occur due to factors such as transaction costs, fees, or changes in the fund's cash flow.

  • Cost Efficiency: Since these funds are passively managed, they typically have lower expense ratios compared to actively managed funds. This cost efficiency is a significant advantage for investors, as lower expenses mean that a larger portion of the fund's returns is passed on to the investor.

The best Small Cap Index Funds are designed to give investors exposure to this segment of the market without the need to individually select stocks. By investing in these funds, investors can benefit from the collective performance of small-cap companies while also diversifying their risk across multiple stocks.

Example:Imagine an investor named Ramesh who wants to invest in small-cap companies due to their growth potential. Ramesh could either try to pick individual small-cap stocks himself, which would require significant research and carry the risk of choosing poorly performing companies, or he could invest in a Small Cap Index Mutual Fund. By choosing the latter, Ramesh gains exposure to a broad portfolio of small-cap stocks that closely follows the performance of an established small-cap index. This not only saves him time but also reduces the risk associated with picking individual stocks.

Example:Consider a Small Cap Index Mutual Fund that tracks the Nifty Smallcap 100 Index. If the index increases by 8% over a year, the fund aims to deliver a similar return, minus its expenses. If the fund's expense ratio is 0.5%, the net return to investors would be approximately 7.5%, assuming no tracking errors.

Who Should Invest in a Small Cap Index Mutual Fund?

Investing in a Small Cap Index Mutual Fund is a decision that should align with an investor's financial goals, risk tolerance, and investment horizon. These funds are not a one-size-fits-all solution, and they may not be suitable for all types of investors.

Ideal Investors for Small Cap Index Funds:

  1. Long-Term Investors: Small-cap stocks are known for their potential to generate high returns, but this potential often takes time to materialize. Investors with a long-term perspective (typically 5 to 10 years or more) are better positioned to benefit from the growth of small-cap companies. The long-term horizon allows investors to ride out the volatility that is characteristic of small-cap stocks.

  2. Risk-Tolerant Investors: Small-cap stocks can experience significant price swings due to their size and market position. Investors who are comfortable with higher levels of risk and can withstand short-term volatility in pursuit of long-term gains are ideal candidates for these funds.

  3. Growth-Oriented Investors: Investors looking to enhance the growth potential of their portfolios may find small-cap index funds appealing. These funds provide exposure to companies that are in the growth phase of their lifecycle, with the potential for substantial appreciation in value.

  4. Diversified Investors: Small Cap Index Mutual Funds can be a valuable addition to a diversified investment portfolio. By including these funds, investors can spread their risk across different market segments, reducing the impact of underperformance in any single area.

  5. Passive Investors: Individuals who prefer a hands-off approach to investing and are satisfied with returns that match market benchmarks may find small cap index funds to be an appropriate choice. These funds require minimal active management and are designed to closely follow the performance of the index.

Who Should Avoid Small Cap Index Funds?

  1. Short-Term Investors: If you are investing with a short-term goal in mind (less than 5 years), small-cap index funds may not be the best option. The inherent volatility of small-cap stocks can lead to significant short-term fluctuations in the value of your investment.

  2. Conservative Investors: Those with a low tolerance for risk or who prioritize capital preservation over growth may want to avoid small cap index funds. The higher risk associated with small-cap stocks may not align with conservative investment strategies.

  3. Investors with Limited Market Knowledge: While small cap index funds are passively managed, understanding the nature of small-cap stocks and their behavior in different market conditions is important. Investors who are not familiar with these aspects may find it challenging to manage their expectations and may be better suited to more stable investment options.

Factors to Consider While Investing in Small Cap Index Mutual Funds

Investing in Small Cap Index Mutual Funds requires careful consideration of various factors to ensure that the investment aligns with your financial goals and risk tolerance. Here are the key factors to evaluate:

  1. Fund Performance: The historical performance of the fund is a critical factor to consider. While past performance is not a guarantee of future results, it provides insights into how the fund has performed relative to its benchmark index over different market cycles. Look for consistency in performance and compare it with the performance of similar funds and the benchmark index.

  2. Expense Ratio: The expense ratio is the annual fee that funds charge their investors to cover operating expenses. Since small-cap index funds are passively managed, their expense ratios should be relatively low compared to actively managed funds. A lower expense ratio translates into higher net returns for investors.

  3. Tracking Error: Tracking error measures the difference between the returns of the fund and the returns of the index it tracks. A lower tracking error indicates that the fund closely follows the index, which is desirable for an index fund. Consistently high tracking errors may indicate inefficiencies in the fund's management.

  4. Volatility: Small-cap stocks are known for their volatility, and this volatility is reflected in the performance of small-cap index funds. Assess your risk tolerance and ensure that you are comfortable with the potential fluctuations in the value of your investment. It's important to be prepared for periods of high volatility and not to react impulsively to short-term market movements.

  5. Fund Manager's Experience: Although small-cap index funds are passively managed, the experience and expertise of the fund manager play a role in maintaining the portfolio and minimizing tracking errors. A seasoned fund manager with a strong track record in managing index funds can add value by ensuring that the fund accurately tracks the index and efficiently manages cash flows.

  6. Investment Horizon: Your investment horizon is the length of time you plan to hold your investment before needing to access the funds. Small-cap stocks typically require a long-term horizon to realize their growth potential. Ensure that your investment horizon aligns with the typical time frame needed for small-cap stocks to deliver returns.

  7. Market Conditions: Small-cap stocks tend to perform better during certain market conditions, such as during periods of economic expansion or when investor sentiment is positive. Conversely, they may underperform during economic downturns or periods of high market volatility. Consider the current and projected market conditions before making an investment in small-cap index funds.

How to Invest in Small Cap Index Funds?

Investing in Small Cap Index Funds is a straightforward process, and there are multiple channels through which you can invest:

  1. Directly through the Fund House: One of the most direct ways to invest in a Small Cap Index Mutual Fund is by purchasing units directly from the mutual fund company. This can be done through the fund house's website or by visiting their office. Investing directly often comes with the advantage of a lower expense ratio, as there are no intermediaries involved.

  2. Through Online Platforms: Several online investment platforms and apps allow you to invest in mutual funds with ease. These platforms provide tools and resources to help you make informed investment decisions. You can compare different funds, track your investments, and even set up Systematic Investment Plans (SIPs) to automate your investments.

  3. Via a Financial Advisor: If you prefer personalized guidance, consulting a financial advisor can be a valuable option. A financial advisor can help you assess your financial goals, risk tolerance, and investment horizon, and recommend the most suitable small-cap index funds for your portfolio. They can also provide ongoing advice and help you adjust your investments as needed.

  4. SIP (Systematic Investment Plan): Investing in small-cap index funds through a SIP allows you to invest a fixed amount regularly, such as monthly or quarterly. This approach can help in averaging out the cost of investment over time, reducing the impact of market volatility. SIPs are particularly useful for investors who want to build wealth gradually and systematically.

  5. Lump Sum Investment: If you have a large sum of money to invest, you can opt for a lump sum investment in a small-cap index fund. This is ideal for investors who are confident about the market's long-term potential and prefer to invest their capital all at once. However, it's important to consider the timing of your investment and the current market conditions to avoid entering the market at a peak.

  6. Retirement Accounts: Small-cap index funds can also be included in retirement accounts, such as the Public Provident Fund (PPF), Employee Provident Fund (EPF), or National Pension System (NPS). These accounts offer tax benefits and are designed for long-term investment, making them suitable for holding small-cap index funds.

Example: Suman, a 35-year-old professional, decides to invest in a small cap index fund to diversify her retirement portfolio. After consulting with her financial advisor, she sets up a SIP of INR 5,000 per month in the Nifty Smallcap 100 Index Fund. Over the next 15 years, Suman benefits from the compounding effect of her investments, and her portfolio grows in value, helping her achieve her retirement goals.

Taxation on Small Cap Index Funds

The taxation of Small-cap index funds is dependent on the duration of the investment. Any profits earned on the investment before one year has passed from the date of purchase will be considered short-term capital gains (STCG) and be subject to a 20% tax.

On the other hand, profits on an investment held for more than a year will be classified as long-term capital gains (LTCG). Tax is not charged on long-term capital gains if the total earning is less than or equal to Rs. 1.25 lakh during the financial year. However, if the amount is over Rs. 1.25 lakh, the additional amount will be taxed at a rate of 12.5% without indexation.

For instance, if the long-term capital gains of an equity mutual fund for a particular financial year is Rs. 3 lakh, then Rs. 1.25 lakh will be tax-exempt while the remaining Rs. 1.75 lakh will be taxed at 12.5%.

Major Advantages of Small Cap Index Mutual Funds

Investing in Small Cap Index Mutual Funds offers several advantages, making them an attractive option for investors seeking growth potential in their portfolios:

  1. High Growth Potential: Small-cap companies are often in the early stages of their growth cycle, which means they have significant room for expansion. As these companies grow and mature, the value of their stocks can increase substantially, providing investors with the potential for high returns. By investing in a small-cap index fund, you can capture this growth potential across a broad range of small-cap stocks.

  2. Diversification: Small-cap index funds invest in a wide range of small-cap stocks, providing diversification within the small-cap segment. This diversification helps spread risk across multiple companies and sectors, reducing the impact of poor performance by any single stock on the overall portfolio. Diversification is a key principle of investing and can help manage the risks associated with small-cap stocks.

  3. Cost-Effective: One of the primary advantages of small-cap index funds is their cost-effectiveness. Since these funds are passively managed, they typically have lower expense ratios compared to actively managed funds. Lower expenses mean that more of the fund's returns are passed on to investors, enhancing the overall return on investment.

  4. Ease of Access: Small-cap index funds are easily accessible to retail investors. You can invest in these funds through various channels, including direct investments, online platforms, and financial advisors. The minimum investment requirement is often low, making it easy for investors to start building their portfolios without a large initial outlay.

  5. Transparency: Small-cap index funds offer transparency in their holdings and operations. Since these funds track a specific index, their holdings are publicly available, allowing investors to see exactly which stocks they are invested in. This transparency can help investors make informed decisions and understand the composition of their portfolios.

  6. Passive Management: The passive management approach of small-cap index funds reduces the risk of human error in stock selection. Fund managers do not attempt to pick individual stocks or time the market; instead, they focus on replicating the index's performance as closely as possible. This approach minimizes the potential for underperformance due to poor stock selection or market timing.

Example: Ravi, a young investor, is looking for a low-cost investment option that provides exposure to the high-growth potential of small-cap stocks. He chooses to invest in a small cap index fund with a low expense ratio. Over time, Ravi benefits from the fund's passive management and the growth of the small-cap companies in the index, achieving a solid return on his investment.

Risks Involved While Investing in Small Cap Index Mutual Funds

While Small Cap Index Mutual Funds offer attractive growth potential, they also come with certain risks that investors need to be aware of:

  1. High Volatility: Small-cap stocks are more volatile than large-cap stocks, leading to larger fluctuations in the value of small-cap index funds. This volatility can result in significant short-term losses, especially during periods of market turbulence. Investors need to be prepared for these fluctuations and have the ability to hold onto their investments during downturns.

  2. Market Risk: The performance of small-cap index funds is closely tied to the overall market conditions. During economic downturns or periods of negative market sentiment, small-cap stocks may underperform, leading to declines in the value of the fund. Market risk is inherent in all equity investments, and small-cap stocks are particularly sensitive to changes in economic conditions.

  3. Liquidity Risk: Small-cap stocks often have lower trading volumes compared to large-cap stocks, which can make them less liquid. This means that it may be more difficult for the fund to buy or sell these stocks without affecting their prices. Liquidity risk can lead to wider bid-ask spreads and increased transaction costs for the fund.

  4. Limited Information: Small-cap companies may not have as much publicly available information as larger companies, making it harder to assess their financial health and growth prospects. This lack of transparency can increase the risk of investing in these companies, as investors may not have access to all the information needed to make informed decisions.

  5. Tracking Error: While small-cap index funds aim to replicate the performance of the underlying index, there can be slight deviations due to tracking errors. Tracking errors can occur due to factors such as transaction costs, changes in the composition of the index, or cash flows into and out of the fund. A high tracking error can result in the fund underperforming its benchmark.

  6. Economic and Sectoral Risks: Small-cap companies may be more susceptible to economic and sectoral risks. For example, a slowdown in a specific sector that a small-cap company operates in can have a more significant impact on its stock price compared to a large-cap company with diversified operations. Additionally, small-cap companies may be more vulnerable to changes in interest rates, inflation, and currency fluctuations.

FAQs

What is the difference between small-cap index funds and actively managed small-cap funds?

Small-cap index funds are passively managed and aim to replicate the performance of a small-cap index, while actively managed small-cap funds involve fund managers selecting stocks in an attempt to outperform the market. Active funds may have higher potential returns but also come with higher risks and costs.

Can small-cap index funds be included in a retirement portfolio?

Yes, small-cap index funds can be included in a retirement portfolio, especially for investors with a long-term horizon and a higher risk tolerance. These funds can provide growth potential over time, which is important for building wealth for retirement.

How often should I review my investment in small-cap index funds?

It is advisable to review your investment in small-cap index funds at least annually or when there are significant changes in market conditions or your financial goals. Regular reviews can help ensure that your investment strategy remains aligned with your objectives.

Are small-cap index funds suitable for SIP investments?

Yes, small-cap index funds are well-suited for SIP investments. SIPs allow you to invest regularly and benefit from rupee cost averaging, which can reduce the impact of market volatility on your investment.

What should I do if the small-cap index fund underperforms the index?

If the small-cap index fund consistently underperforms the index, it may be due to a high tracking error or other factors. Consider evaluating the fund's performance, expense ratio, and tracking error before deciding whether to continue with the investment or switch to another fund.

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