Your Questions Answered: What is Nifty Smallcap250 Quality 50 Index?

Q. I am a 27-year-old electrical engineer working with an MNC in Navi Mumbai. I have been working since the past 2 years and have invested only in tax-saving fixed deposits and large-cap mutual funds. Some of my acquaintances have suggested that I diversify and invest in smallcap and midcap mutual funds. Recently I came across certain index mutual funds tracking Nifty Smallcap250 Quality 50 Index. Can you please elaborate on the Nifty Smallcap250 Quality 50 Index?

Tribhuvan Chauhan, Patna, Bihar

Small-cap stocks offer high potential returns but also come with inherent volatility. Enter the Nifty Smallcap250 Quality 50 Index, a unique index targeting quality companies within the small-cap realm, aiming to deliver superior returns with potentially controlled risk. 

The Nifty Smallcap250 Quality 50 Index was launched by NSE Indices Limited (formerly known as India Index Services & Products Limited) in December 2017. It is part of the Nifty family of indices, which are the most widely used benchmarks for the Indian equity market.

What is it?

The Nifty Smallcap250 Quality 50 Index is a benchmark that tracks 50 high-quality companies handpicked from the broader Nifty Smallcap250 Index. These chosen companies undergo a rigorous selection process based on three key parameters:

• Return on equity (ROE): Measures profitability and how efficiently a company manages its shareholders' equity.
• Financial leverage (Debt-to-Equity Ratio): Assesses the company's financial stability and debt burden.
• Earnings growth variability: Analyses the consistency of the company's earnings growth over the past five years.

How does it work?

Companies from the Nifty Smallcap250 are assigned "quality scores" based on the three parameters mentioned above. The top 50 companies with the highest scores make it to the index. Additionally, the weightage of each stock within the index is determined by a combination of its quality score and free-float market capitalization. This ensures a balance between quality and market representation. The index is derived from its parent index, Nifty Smallcap 250, which includes the bottom 250 companies from the Nifty 500 index based on their free float market capitalization. 

Top 10 constituents by weightage

(As of December 20, 2023)

1. Aarti Industries: Leading API manufacturer riding the pharma boom.
2. Poly Medicure: Surgical glove specialist capitalising on healthcare demand.
3. Astral Poly Technik: Plastic pipe leader reaping benefits of infrastructure focus.
4. Dixon Technologies: Electronics contract manufacturer powering tech growth.
5. Laurus Labs: API and generics player carving a niche in complex molecules.
6. PI Industries: Specialty chemicals champion fueling diverse industries.
7. Alkyl Amines Chemicals: Essential amino producer catering to diverse needs.
8. Indoco Remedies: Branded generics expert playing on affordable healthcare wave.
9. Deepak Nitrite: Diversified chemical giant benefiting from agri and infra booms.
10. Ajanta Pharma: Formulations and API powerhouse expanding globally.

Benefits of investing

• Potentially higher returns: By focusing on quality companies with strong fundamentals, the index aims to outperform the broader small-cap market over the long term.
• Reduced volatility: Compared to the broader small-cap index, the Nifty Smallcap250 Quality 50 might exhibit lower volatility due to the selection criteria emphasising financial stability and consistent earnings growth.
• Passive investment opportunity: Index funds that track the Nifty Smallcap250 Quality 50 offer a convenient and cost-effective way to gain exposure to a basket of high-quality small-cap companies.

Cons to consider

• Concentration risk: With only 50 stocks, the index is more concentrated than the broader small-cap universe, potentially exposing investors to higher sector-specific risks.
• Limited sector diversification: Certain sectors like telecom and power struggle to find representation in the index due to their typically high leverage, resulting in potential underperformance when those sectors outperform.
• Relatively new index: Launched in 2017, the index's long-term performance track record is yet to be established.

Who should invest?

• Investors with a long-term horizon: This index is suitable for investors willing to ride out the inherent volatility of small-cap stocks and focus on long-term potential returns.
• Investors seeking quality exposure: Those seeking exposure to high-quality, fundamentally strong small-cap companies can consider this index as a core holding within their portfolio.
• Risk-averse investors: While small-cap inherently carries higher risk, this index, with its focus on quality, may be suitable for investors with a moderate risk appetite seeking additional growth potential compared to broader market indices.

In conclusion, the Nifty Smallcap250 Quality 50 Index is a stock market index that tracks the performance of the top 50 high-quality small-cap stocks in India. The index offers exposure to high-quality small-cap companies that have strong fundamentals and growth potential while diversifying across sectors and industries. The index can be a suitable investment option for investors who have a high risk appetite and a long-term investment horizon, and who want to generate higher returns than the broader small-cap market. 

However, investors should also be aware of the risks and challenges associated with investing in small-cap indices, such as higher volatility, lower liquidity, and tracking errors. Investors can invest in the Nifty Smallcap250 Quality 50 Index through mutual funds or ETFs that track the index performance. However, investors should also do their own research and analysis before investing in any index fund or ETF.

Kuvera is a free direct mutual fund investing platform.

Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.