What Is Small-Cap ETF?

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Enjoy index Fund benefits with Small-Cap ETFs

Key Takeaways

• Small-Cap ETFs invest in a basket of securities of companies with smaller market capitalisation.
• These ETFs have attributes of both mutual funds and stocks.
• Small-Cap ETFs are listed on the stock market and get traded frequently.
• Frequently traded ETFs are highly liquid.
• NAV of Small-Cap ETFs gets impacted by market conditions and is subject to risks.

While mutual funds invest across asset classes, quite a few closely replicate the stock market. A fund that tracks the market index always aims to mirror its index’s returns. Mutual Funds also require you to time the market and NAV, something that a stock-market-replicating fund does not need. Read on to find out more about Small-Cap ETFs and their benefits.

What is Small-Cap ETF?

Firstly, let us understand the meaning of Small-Cap and ETFs separately. Small-Cap is an indicative term for the market capitalisation of a company. A company with a market capitalisation of less than INR 500 Cr is a small-cap company, and stocks of such a company are called small-cap stocks. An Exchange Traded Fund or ETF is a basket of securities that are traded on stock markets. Therefore, Small-Cap ETFs are funds invested in the basket of securities of small-cap funds.

How do Small-Cap ETFs work?

Structure-wise and management-wise, ETFs are similar to mutual funds. Like mutual funds, ETFs gather money from investors and help investors to diversify their portfolios by investing across asset classes of small-cap stocks, bonds, etc. Small-Cap ETFs in India are listed on the stock exchanges and get traded as such. The price of the underlying assets is directly proportional to the share price of the ETF.

Fund managers manage the ETF actively or passively. Passively managed ETFs and Index Funds share similar characteristics, i.e., they follow a market index and invest in the companies listed on that index.

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Advantages of Investing in Small-Cap ETFs

Liquidity

ETFs have attributes of stocks. Hence, you can buy and sell Small-Cap ETFs on the stock exchange.

Lower costs

Usually, a mutual fund scheme comes with an expense ratio, entry and exit loads, management fees etc. However, the expense ratios of ETFs are relatively lower. Small-Cap companies sell stocks at lower prices to counter market conditions, making the overall cost of Small-Cap ETFs lower.

Diversification

When you purchase shares of a company, your returns are limited to the performance of that company. Small-Cap ETFs, however, enables you to allocate assets across equities of different small-cap companies.

Things to Consider

• If not traded frequently, Small-Cap ETFs are illiquid, making it difficult to find buyers or sellers.
• Small-cap companies are highly volatile. The NAV of such funds gets impacted by market conditions and is subject to systematic and unsystematic risks.
• Small-Cap ETFs generate good returns during bullish market cycles, while you may accrue lower returns during bear markets.
• Small-Cap ETFs require time to generate returns and should be held for the long term.
• Short-term capital gains from ETFs held for up to one year are taxed at 15%, whereas long-term capital gains from ETFs held for over one year are taxed at 10%, without indexation benefits, if gains exceed INR 1 Lakh per annum.

Conclusion

Small-Cap ETFs invest in companies with massive growth potential. As an investor, you are fundamentally investing in multiple companies with ETFs. Therefore, with ETFs, you can expect to earn higher returns with lower investment costs.

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*Disclaimer: This article is for information only. We recommend you get in touch with your income tax advisor or CA for expert advice.