Motilal Oswal Mutual Fund’s decision to pause fresh investments in its Nifty Microcap 250 Index Fund effective January 8, 2026, has drawn attention to the regulatory ambiguity surrounding micro-cap stocks. While the move was prompted by classification concerns rather than market conditions, it has reignited the debate on whether micro-caps are inherently too risky or illiquid for fund portfolios.
Unlike large-, mid- and small-cap stocks, which are clearly defined under AMFI’s market-cap classification, micro-caps remain an undefined segment. Under the current framework, large-cap stocks include the top 100 companies by full market capitalisation; mid-cap stocks rank from 101st to 250th; and small-cap stocks include companies ranked from the 251st position onwards.
However, market participants broadly treat stocks ranked beyond the top 500 by full market capitalisation as micro-caps. This aligns with the coverage universe of the Nifty Microcap 250 Index, which includes 250 companies beyond the Nifty 500 constituents, selected based on average full market capitalisation. This regulatory grey area affects product labelling, often forcing fund houses to adopt a conservative stance on new launches or fresh inflows. For this study, as AMFI does not define micro-cap stocks, we classify stocks ranked 251–500 as small-caps and those ranked beyond 500 as micro-caps.
Where mutual funds hold micro-caps
Despite the absence of a formal definition, mutual funds continue to maintain meaningful exposure to micro-cap stocks across categories. Data from ACE MF show that over the last five years, mutual fund assets in the micro-cap segment (stocks ranked beyond 500) have surged more than 10-fold—from ₹22,508 crore in December 2020 to ₹2.6 lakh crore in December 2025 — accounting for about 5 per cent of total equity assets under management of ₹52 lakh crore as of December 2025.
Micro-cap exposure is most visible in actively managed small-cap funds, which hold 33 per cent, or ₹1.1 lakh crore, of the total equity AUM of ₹3.5 lakh crore. Within small-cap funds, portfolio mandates allow fund managers to venture deeper into the market-cap spectrum, and many schemes hold a tail of micro-cap stocks.
DSP Small Cap tops the chart, with 58 per cent exposure to micro-cap stocks, followed by Tata Small Cap and LIC MF Small Cap, which held 55 per cent and 52 per cent, respectively, as of December 2025.
Apart from small-cap funds, multi-cap funds held a higher share of micro-caps, with a 10 per cent allocation, driven by their mandate to invest at least 25 per cent in small-cap segments. Sectoral and thematic funds also held notable allocations to micro-caps. Some of these include LIC MF Manufacturing (41 per cent), LIC MF Infra (39 per cent), Edelweiss Recently Listed IPO (33 per cent), Samco Special Opportunities (32 per cent), Motilal Oswal Digital India (31 per cent), and UTI Innovation (30 per cent).
Fund managers appear to be using micro-caps selectively rather than aggressively. Position sizes tend to be smaller, and portfolios are often diversified across multiple names to manage stock-specific risks.
Liquidity
Liquidity remains the biggest concern when it comes to micro-caps. The prevailing assumption is that these stocks cannot absorb large redemptions without causing significant price impact. Interestingly, based on the SEBI–AMFI liquidity stress-test methodology, bl.portfolio calculations for the Motilal Oswal Nifty Microcap 250 Index Fund indicate that 50 per cent of the portfolio can be liquidated in just two days. However, the lower liquidation period is due to the fund’s relatively small AUM of ₹2,626 crore.
Performance cycles
Return data reinforce why mutual funds approach micro-caps with caution. Rolling return analysis shows that micro-cap indices tend to deliver sharp bursts of outperformance during bullish phases, often exceeding small- and mid-cap returns over specific periods. However, these phases are cyclical, with micro-caps often turning into underperformers during market corrections.
Over the long run, micro-caps have tended to deliver higher returns compared to other market-cap segments. Back-tested index data show that over the last 20 years, the Nifty Microcap 250 Total Return Index (TRI) delivered a compounded annualised growth rate (CAGR) of 17.5 per cent, compared with 13.5 per cent for the Nifty Smallcap 250 TRI.
Risk characteristics
Drawdown analysis paints a starker picture. Micro-cap indices experience deeper and faster drawdowns during market corrections, with recovery periods often extending longer than those of small-cap segments. During the global financial crisis in 2008, the Nifty Microcap index declined 82 per cent, compared with a 76 per cent decline in the Nifty Smallcap index. During the Covid-19 crash in 2020, the micro-cap index corrected sharply by 70 per cent, versus a 59 per cent decline in the small-cap index.
What this means for investors
Regulators are likely to revisit mutual fund categorisation norms and market-capitalisation definitions as India’s equity universe continues to evolve. The recent pause on fresh inflows into the micro-cap index fund signals regulatory prudence, not a rejection of the micro-cap space. Mutual fund portfolios continue to show meaningful participation, supported by improving market depth and liquidity.
For investors, the takeaway is nuanced. Micro-caps are neither uninvestable nor appropriate as core portfolio allocations. They require higher risk tolerance, longer investment horizons, and disciplined position sizing. As India’s equity market expands and matures, micro-caps are likely to remain a volatile yet relevant segment of the mutual fund universe — best approached selectively rather than avoided altogether.
Investors, while aligning their asset allocation and seeking micro-cap exposure, may consider well-rated active small-cap funds with meaningful allocations to this segment. Based on bl.portfolio Star Track Ratings, funds with notable micro-cap exposure include DSP Small Cap Fund (58 per cent), Nippon India Small Cap Fund (29 per cent), and Axis Small Cap Fund (25 per cent). A systematic investment plan (SIP) is a preferred mode of investment for holding periods of 10 years or more.
Published on January 17, 2026
