Mid-Cap and Small-Cap Index Funds in India: Current Landscape and Future Prospects

India's capital markets have witnessed significant growth over the years, with a plethora of investment options available to investors. However, one area that has been somewhat overlooked is the availability of mid-cap and small-cap index funds. This article explores why these funds are not widely available in India, the recent developments, and the future prospects for their growth.

Understanding Index Funds and Mid-Cap Companies

To understand why mid-cap and small-cap index funds are not more prevalent, it is crucial to first understand the nature of index funds and mid-cap companies.

What is an Index Fund?

An index fund is a type of investment fund that aims to track the performance of a specific market index. By investing in an index fund, investors gain exposure to a basket of securities that represent the index. Index funds are popular due to their low management fees, transparency, and passive nature, making them an appealing choice for many investors.

Mid-Cap Companies in India

Mid-cap companies refer to firms that have a market capitalization between Rs 5000 to 20000 crores. These companies typically have more market potential than small-cap firms but are still growing and adapting to market dynamics. The mid-cap category is therefore a vital segment within the Indian capital market.

The NIFTY 150 Midcap Index: A Benchmark for Mid-Cap Funds

Traditionally, the NIFTY 150 Midcap index has been the benchmark for mid-cap funds in India. This index consists of companies ranked between 101 and 250 from a total of 500 large-cap companies listed on the National Stock Exchange (NSE). The NIFTY 150 Midcap index aims to provide a broader representation of the mid-cap segment, capturing the growth potential of these companies.

Recent Developments: Motilal Oswal Launches Mid-Cap and Small-Cap ETFs

While mid-cap index funds have been limited, the recent actions of Motilal Oswal mark a significant shift. In a move that promises to bring more transparency and options to investors, Motilal Oswal has launched index funds in both mid-cap and small-cap spaces. This development is indicative of a growing awareness and demand for structured and accessible investment options.

The Demand and Supply Game: The Backbone of Market Dynamics

The limited availability of mid-cap and small-cap index funds can largely be attributed to the demand and supply dynamics in the market. Active fund managers have traditionally provided better alpha, or excess returns, compared to passive index funds. This gives active managers an edge in capturing investor interest.

The second factor is the low expense ratio associated with index funds. Since index funds are passive in nature, they do not require extensive research and management, leading to lower fees. Distributors, who play a crucial role in pushing such funds, do not find it economically viable to promote these funds due to their lower margins.

Transition Towards a More Efficient Market

Despite these challenges, the Indian capital market is slowly moving towards a more efficient and cost-conscious paradigm. As active managers face increasing pressure to deliver consistent alpha, there is a growing interest in passive investing.

According to the latest SPIVA report, only 62.77% of active large-cap managers in India outperformed the market over a five-year period, compared to 89% in the US. This trend is expected to influence investor behavior and push AMCs to offer more index fund options.

Emerging Trends in the Indian Capital Market

Several signs point towards a growing interest in index funds, particularly among the younger generation of investors who are more concerned about long-term financial growth and cost efficiency.

ICICI500 ETF
ICICI launched the ICICI500 ETF, which is the only broad-market fund in India. This fund aims to provide exposure to a diversified range of companies, thereby reducing risk and offering potential returns.

Factor-Based Funds
Relyance, ICICI, Kotak, SBI, and Sundaram have launched smart-beta fundamentally weighted factor funds, which are designed to provide exposure to specific market factors while still maintaining a low expense ratio.

Low Expense Ratio Funds
UTI has introduced Nifty and Nifty Next 50 funds with low expense ratios, making investment in these mid-cap and small-cap segments more accessible to a broader audience.

Conclusion: The Future of Mid-Cap and Small-Cap Index Funds

The Indian capital market is witnessing a paradigm shift towards more transparent and cost-effective investment options. With active managers under increasing pressure to deliver consistent results, the demand for index funds is likely to grow in the coming years. As more investment firms like Motilal Oswal launch mid-cap and small-cap ETFs, investors will have a wider range of options to choose from, making the Indian capital market more accessible and efficient.

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