Traditionally, large and small-cap funds have appealed to investors looking for stability and growth. However, markets are maturing, and investors are seeking newer options to capitalise on. In this context, you must learn about microcap funds. These mutual fund schemes have been designed to invest in the smallest companies that have been listed in the market. While they carry a higher risk potential, they also bring you the opportunity to capitalise on early growth.
Microcap funds appeal to investors with patience and discipline. Instead of a speculative gamble, these funds present you with a powerful opportunity for growth.
What Are Microcap Funds?
Microcap mutual funds invest in companies that come at the lowest end of market capitalisation. These businesses are even smaller than typical small-cap companies. In most cases, microcap companies are in their early phases of expansion.
These companies might operate in niche segments like emerging industries or regional markets. Microcap companies don’t receive much coverage from analysts. As a result of this lack of attention, they create both opportunity and risk. Microcap funds identify these businesses early, much before the rest of the market realises their actual potential.
Why Microcap Funds Offer High Growth
Investors get the opportunity to capitalise on growth right from the start with microcap funds. These companies operate on a smaller scale. This implies that even small improvements in revenue or profitability lead to significant returns from stocks.
Structural shifts also benefit microcap businesses. These include:
· Digital adoption
· Formalisation of supply chains
· Rising domestic consumption
Since these companies tend to be under-researched, their strong fundamentals remain unnoticed for long periods. Historically, many successful mid-cap and large-cap stocks began their journey as microcaps, and early investors reaped handsome returns.
The Role of Fund Managers in Microcap Investing
Fund managers have a critical role to play in microcap funds. Managers assess various aspects like:
· Business models
· The credibility of promoters
· Governance standards
· Long-term credibility
Another key responsibility is liquidity management, as microcap stocks are sometimes traded in thin volumes. Therefore, fund managers need to balance conviction with sizing the position in order to avoid excessive impact costs.
Risks Involved in Microcap Funds
With the high growth potential of microcap funds comes equally high risks.
1. Higher volatility
Microcap stocks tend to be more volatile. During market downturns, they often experience sharp swings.
2. Liquidity constraints
The risk of liquidity is significantly high in microcap funds. Sometimes, it becomes challenging to exit positions quickly.
3. Corporate governance risks
Corporate governance issues and limited disclosures are some of the other challenges that microcap funds face. Also, these companies are sensitive to economic slowdowns. With funding constraints and regulatory changes, prices may significantly fluctuate.
This volatility isn’t something short-term investors are comfortable with. That’s why microcap funds aren’t suitable for those looking for quick gains.
How Investors Should Approach Microcap Funds
As an investor, you may include microcap funds as a small, satellite allocation in your portfolio. Consider a long-term horizon for these stocks, and plan to stay invested for at least five to seven years.
You may create an SIP in one of the popular funds like the Motilal Oswal Nifty Microcap 250 Index Fund. With a systematic investment plan, you can manage market timing risks and smooth out volatility.
Avoid overexposure to microcap funds and rebalance your portfolio periodically to lock in the gains.
Conclusion
Microcap funds open the door for some of the most promising growth prospects in equity markets. However, you need patience and risk awareness as you invest in these mutual funds.
With a thoughtful approach, microcap funds can occupy a small part of your portfolio, driving long-term returns. The strategy shouldn’t be chasing quick gains, but to commit yourself to a well-researched approach to investment.
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