Why Max Life Nifty Smallcap Quality Index Fund is a smart investment decision?

India’s growth story is now a well-established fact and is being recognized globally. In a world of slowing economic growth rates, India is climbing up the ranks and is all set to achieve $5 trillion GDP size in the coming years.  As a retail investor you might be wondering how can you also be a part of India’s incredible growth story.

One way of achieving the objective is through equity investments in high quality small cap companies that offer strong growth potential. Let’s find out how Max Life Nifty Smallcap Quality Index Fund (SFIN: ULIF02702/08/23NIFTYSMALL104), the industry’s first small-cap index fund, can tap into India’s growth story, by replicating an Index that has provided CAGR returns in excess of 22% over a 10-year period (past performance does not guarantee future returns). But first the basics – why do small cap stocks make sense in the current situation.

What are Small Cap Stocks and What’s the Reason for their Growth Potential?

As per SEBI’s definition, the listed stocks in India can be divided into 3 key categories when ranked as per their free-float market capitalization*:

·         Large Cap Stocks: Rank 1st to 100th (Total companies 100)

·         Midcap Stocks: Rank 101st to 250th (Total companies 150)

·         Smallcap stocks: Rank 251st onwards (Total companies 4813)

*As per SEBI circular no. SEBI/HO/IMD/DF3/CIR/P/2017/114 dated 6th October 2017

As you can see, the small-cap stock universe is significantly larger than the other two categories combined in terms of number of companies and there-in lies an opportunity to generate outstanding returns. In fact, data published by AMFI (Association of Mutual Funds in India) on 30th June 2023 shows that 9 small-cap stocks were elevated to mid-cap category which means that the market cap of these companies has increased considerably which translates to high returns for investors.

Another factor to consider are the key sectors in which these small-cap companies operate. Here’s a snapshot:

KEY SECTORS

Defense
Chemicals
Railways
Logistics

Infrastructure
Electronics
Building Material
T&D Equipment

Medical Equipment
Industrial Products
Auto ancillaries
Packaging

Drone Manufacturing
Textiles
Water supply
Trading

Pipes
Sugar
Fertilizers
Small Finance Bank

Capital Market Intermediaries
Construction
Shipping
E-learning

As you can see from above list, on one hand small-cap companies operate in well-known segments like infrastructure, electronics, sugar, textiles, fertilizers and on the other hand, they are also present in niche segments with high growth potential like e-learning, drone manufacturing, railways and Defence. Such opportunity for diversification is definitely not easy to come by.

Why Opt for Index Investing for Smallcap Stocks?

If you are a market veteran who understands terms like bottom-up investing, alpha, beta, candle-stick patterns, inverted yield curve and so on, selecting a multi-bagger stock might not be too difficult. However, not all retail investors are so knowledgeable and that’s why many opt for actively managed funds, where a fund manager along with a team of analysts decides which stocks to buy, sell or hold.

Passive investments attempt to replicate the performance of the index they are tracking. They invest in exactly the same stocks as the index and maintain the exact same weight that each stock has on the index. This would eliminate key non-systemic risks like active stock picking and portfolio rebalancing by the fund manager. In passive investing, portfolio rebalancing does occur but only on a bi-annual basis at the time of index rebalancing. The goal is to generate the same returns as the benchmark. One example of such passive investment is an index fund that mimics the performance of its chosen index. Some of the key benefits of passive investments over actively managed funds include:

·         No Fund manager bias as there is no active stock picking

·         Low fund management fees

·         Low churning of the portfolio due to minimal portfolio adjustments and buying/selling of stocks

·         Higher transparency as portfolio is a replica of the index being tracked

·         Algorithm based stock picking that reduces possible errors due to manual intervention

As a result of the above benefits, Index investing makes more sense for small caps than trying to pick individual small-cap stocks from a universe of close to 5000 companies. The next logical step here would be to choose a specific small cap index that provides potentially high long-term returns and our answer is the Nifty Smallcap 250 Quality 50 Index. Here’s why.

What is the Nifty Smallcap250 Quality 50 Index?

There are a number of well-known small-cap indices in India that are used as benchmarks by different small-cap funds. Some of these indices are the Nifty Smallcap 50, Nifty Smallcap 100, Nifty Smallcap 250, etc. These broad-based indices are created based on a single parameter – the free-float market cap of listed stocks. For example, the Nifty Smallcap 250 Index consists of NSE listed stocks that are ranked 251st to 500th based on their free-float market capitalization.

The Nifty Smallcap250 Quality 50 Index, is a strategy index that selects 50 high quality stocks from the list of Nifty Smallcap 250 Index companies based on some key quality parameters like:

·         Profitability (return on equity)

·         Earnings Growth (earnings per share variability over a 5-year period)

·         Debt levels (financial leverage)

There are also some key exclusion criteria that are considered – companies with promoter share greater 20% and those without futures and options trades are not considered for inclusion. So, only 50 small-cap stocks with the highest quality scores based on the above parameters are featured on this index. Below are the top 10 stocks featured on the index and their individual weight as of 31st July 2023:

Company’s name
Weight (%)

Indian Energy Exchange Ltd.
4.40

Castrol India Ltd.
4.22

Sonata Software Ltd.
4.11

Central Depository Services (India) Ltd.
3.82

KEI Industries Ltd.
2.94

National Aluminium Co. Ltd.
2.89

Redington Ltd.
2.77

J.B. Chemicals & Pharmaceuticals Ltd.
2.63

Carborundum Universal Ltd.
2.61

Sanofi India Ltd.
2.61

As you can see from above table, these stocks are from various sectors, which indicates that the index is well-diversified. Here’s a closer look at the various sectors that are featured on the Nifty Smallcap 250 Quality 50 Index and their individual weights as of 31st July 2023:

Sector
Weight (%)

Capital Goods
19.89

Information Technology
12.74

Financial Services
11.84

Oil, Gas & Consumer Goods
8.95

Chemicals
8.71

Fast-moving Consumer Goods
8.52

Healthcare
7.68

Consumer Durables
6.47

Services
5.86

Construction
3.83

Metals & Mining
2.89

Textiles
2.61

So an index fund that replicates this index will be diversified across multiple sectors allowing investors to benefit from the growth of various sections of the economy. To understand why this particular small-cap index makes more sense than a broad-based index for those interested in participating in India’s growth story, let’s take a closer look at the historical returns data.
What are the historical returns offered by Nifty Smallcap 250 Quality 50 Index?
 

*CAGR returns shown above are as of 28 July 2023

The above graph is based on the returns comparison of leading indices as shown below:

Indices
3-year Returns*
5-year Returns*
10-year Returns*

Nifty 50
21.1%
11.6%
13.1%

Nifty Midcap 100
33.6%
16.0%
20.5%

Nifty Smallcap 250
37.5%
13.6%
19.1%

Nifty Smallcap 100
33.6%
16.0%
20.5%

Nifty Smallcap 250 Quality 50
38.6%
16.1%
22.4%

*CAGR returns as of 28 July 2023

 

While past performance does not guarantee future returns, you can see from the above that the Nifty Smallcap 250 Quality 50 Index has outperformed its peers over both the previous 5 year and 10 year periods. This indicates the high long-term growth potential of the small-cap stocks featured on this index.

This historical 22% CAGR of the index over a 10-year period would have grown investor’s wealth manifold. To put this another way, a one-time investment of Rs. 100 made in 2013 would be worth Rs. 730 in July 2023. So as a result of the 22% 10 year CAGR achieved by the index, you would have received over 7X returns in 10 years! This is significantly higher than the growth delivered by any other small-cap index during the same period.

 
Why should you consider investing in Max Life Nifty Smallcap Quality Index Fund?
 

The primary reason to consider investing in the Max Life Nifty Smallcap Quality Index Fund through Max Life Insurance plans is that it offers a unique investment opportunity which combines the benefits of small-cap investments and low-cost index investing with life cover in a single package. You should also consider the below features of the scheme:

Fund objective

The objective of the fund is to invest in a basket of stocks drawn from the constituents of NSE Smallcap 250 Quality 50 index. The fund will invest in the companies of the above index with similar weights as the index and generate returns as closely as possible, subject to tracking error.

Where will the Fund Invest?

Max Life Nifty Smallcap Quality Index Fund follows a passive investment approach and invests only in high quality small-cap stocks that are part of Nifty Smallcap250 Quality 50 Index Fund. This will provide investors with exposure to small-cap companies with high long-term growth potential in a cost-effective manner. The fund management charge of this scheme is 1%, which is lower than many comparable investments.

Key Benefits of Investing in Max Life Nifty Smallcap Quality Index Fund

No fund manager bias

The adoption of passive investing ensures that investment decisions are not impacted by individual fund manager biases or opinions, resulting in a more objective investment approach.

Life Cover

By investing in the Nifty Smallcap Quality Fund through Max Life Insurance plans, you get a life cover of up to 20x the annual premium amount you pay to maintain your investment in the scheme. So, this way the fund combines the benefit of low cost high-growth investment with life cover benefit in a single package.

Low-cost investing

The fund features a low fund management charge or FMC of 1% which is lower that FMC charged by many other currently available small-cap funds. This make it a cost-effective way to invest in small-cap companies and get higher net returns in the long-term.

Multiple Tax Benefits

You get tax benefit when investing in Max Life Nifty Smallcap Quality 50 Index Fund and also at maturity. The investments made in this fund provide tax deduction as per Section 80C (cumulative Rs.1.5 lakh/financial year), while the returns received at maturity are also exempt from the capital gains tax, as per Section 10(10D) of the Income Tax Act, 1961. It must be noted that 10(10D) provisions are applicable if the investment units are held for a period of 5 years or longer and if annual premium payment is up to Rs. 2.5 lakh.

 

ULIP Disclaimers:

In a Unit-Linked Insurance Plan (ULIP) risks in the investment portfolio are borne by the policyholder.

THIS ARTICLE IS NOT WRITTEN BY MC EDITORIAL.