What are Micro-cap Mutual Funds? All you need to know

Ever heard of the next big thing before it was a thing? Micro-cap mutual funds allow you to invest in companies that are likely future growth superstars. However, the scope of fraud has become vast. This has led to our discussion on micro-cap mutual funds and whether they should be included in your overall investment plan.

So, to give you an overall idea of Micro-cap mutual funds, we are presenting this article to you evaluating all of its parts, such as risks, benefits, etc. 

Without any delay, let’s get started!

What Are Micro-cap Mutual Funds?

Micro-cap mutual funds are a type of stock mutual fund that invests in the equity securities of companies with small market capitalizations. Large-cap to mid-cap companies that are generally larger and more established tend not to make such large changes. Micro-cap mutual funds are certainly attractive to those who seek huge growth potential, but these carry extremely higher risks as volatility and liquidity strike micro-cap investing more than any sector of the market.

Overview of Micro-cap companies

Micro-cap: Companies with the smallest market capitalizations, usually ranging from 5 crore to 30 crore. The “micro-cap” designation describes companies that trade under 5 crore in the stock market. Because they are so small, these companies can be more volatile and have a higher degree of risk involved with them compared to others who may be better capitalized, for example (more on this later). 

While they can yield potentially high returns, these investments are also more volatile and subject to heavy losses in down markets. Micro-cap companies are smaller and may not be covered by analysts or followed as closely by individual investors. As such, buying micro-cap companies should involve a lot of your time and research (i.e., risks).

Key characteristics of Micro-cap mutual funds

Micro-cap mutual funds invest in the equity securities of firms with small market capitalizations, not exceeding 5 crores. Micro-cap funds have the prospect of swift growth, but they are riskier due to greater volatility and perceived risk issues. Generally, micro-cap firms are riskier and more volatile than larger, more established enterprises. Investing in micro-cap funds necessitates complete research and acclimatization to the likelihood of heavy losses in bear markets.

Benefits of investing in Micro-cap mutual funds

There are multiple advantages of investing in micro-cap mutual funds; some of them are:

1. High Growth Potential: Smaller companies, such as microcaps, have a lot of room to grow, and this growth can lead to bigger returns if these companies are successful.

2. Portfolio Diversification: Adding micro-cap mutual funds to a well-diversified investment portfolio can spread risk using different asset classes and market segments.

3. Investment: Investing in micro-cap companies allows investors to invest early on with any of the potentially promising businesses before they really become some well-known and expensive.

4. Outperformance Ability: Some investors theorize that micro-cap stocks could outperform their larger counterparts, contributing to better total portfolio returns over a long-term timeframe.

5. Market efficiency: Prices of micro-cap stocks may not be as accurately priced, leaving greater opportunities for the more skillful fund managers to discover bargains

That being said, investors should remember that investing in micro-cap mutual funds poses a higher risk with increased volatilities, weaker liquidity and losses could be heavy as well; hence such investments need to go through ample research or else consider the risk appetite before they think for these specific private equity investment options.

Risks associated with Micro-cap mutual funds

Before investing, knowing the risk factors is also mandatory; let’s list out some of them:

1. Volatility: Micro-cap mutual funds generally have higher volatility compared to larger-cap funds, which has implications for the value wherein it may fall sharply in a shorter space of time.

2. Liquidity Risk: Due to the lower trading volumes of some micro-cap stocks, bid-ask spreads can be wider, and it may potentially be difficult to buy or sell a large number without affecting the stock price.

3. Higher Potential for Business Failure: The smaller companies represented by micro-cap funds can be at higher risk of business failure from a number of factors including limited resources, tough competitive environments and challenging market conditions.

4. Market Sensitivity: Micro-cap stocks may e more volatile during market swings and economic downturns that can result in significant losses during rough times.

Investors must ponder these risks and do the homework necessary to buy micro-cap mutual funds that meet their investment objective and risk-taking capabilities.

How to Choose a Micro-cap mutual fund?

Some of the factors to be considered while choosing a micro-cap mutual fund are:

• Fund Performance: Check how the fund has performed historically and in different time periods. This is a test of the fund’s performance both in bull and bear markets.
• Expense Ratio: Considering the expense ratios of other micro-cap funds. Lower expense ratios can meaningfully affect an investor’s end returns.
• Fund Manager Expertise — Research to see if the fund manager has experience in managing a micro-cap funds. A good fund manager with experience can make a significant difference to the performance of the fund.
• Risk rating: Determine the risk level since they can vary. Match the risk metrics of the fund with your own acceptable level of risks and investment objectives.
• Investment Philosophy: Learn about the investment style and philosophy of a fund. But, ensure it is consistent with your goals and values.
• Fund Holdings: Check the fund’s holdings to see what type of micro-cap companies it invests in, and make sure that these align with your investment strategy.
• Research the Companies: Take a good look at who is invested by searching for the past and future growth potential of those businesses, financial situation as well industry dynamics.
• Exit Strategy: Know the exit tactic used by the mutual fund when dealing with underperforming or overvalued stocks. Understand the way in which the fund manages its portfolio
• Investment minimums: Review the fund’s investment minimum to make sure it suits your financial abilities.

Given this, it is essential to do your homework and maybe seek the advice of a financial advisor so as to verify that any micro-cap mutual fund does fit within your overall investment approach and risk level.

On a parting note…

Mutual Funds – Micro-cap mutual funds are a category of mutual fund that invest in small-cap companies. They can provide substantial upside, but are riskier given the fact they invest in less mature companies with lower cash reserves. Prior to investing, it’s important that you do your own research and comprehend the features of micro cap mutual funds including risks.

Please share your thoughts on this post by leaving a reply in the comments section. Contact us via Phone, WhatsApp, or Email to learn more about mutual funds, or visit our website. Alternatively, you can download the Prodigy Pro app to start investing today!

Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.