Largecap mutual funds trail mid and smallcaps in 2026. Should investors change strategy?

Largecap mutual funds have struggled so far this year, with average returns declining 2.36% on a year-to-date (YTD) basis. In contrast, midcap and smallcap funds have delivered average gains of 8.47% and 15.32%, respectively, according to an analysis by ETMutualFunds.

The sharp divergence in performance of market cap based categories raises an important question for investors: should they continue backing the market’s recent winners or use the correction in large caps as an opportunity to rebalance their portfolios?

Anup Bhaiya, Founder, Money Honey Financial Services told ETMutualFunds that investors should consider rebalancing their portfolios by booking partial profits in outperforming mid- and small-cap funds and shifting some allocation towards large caps. He further said that directing fresh capital into large caps buys quality at lower valuations.


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Shruti Jain, Chief Strategy Officer, Arihant Capital Markets shared with ETMutualFunds that some profit booking in mid- and small-caps after their strong run is “simply good hygiene” and can help investors bring their portfolios back to their original allocation.

However, she cautioned against interpreting this as a signal to exit mid- and small-caps altogether. According to Jain, what appears to be underperformance in large caps is partly a result of valuations cooling to more sensible levels and that’s exactly where fresh money should go.

Jain further said that the key is to rebalance rather than chase performance; fresh investments should be staggered across market-cap segments based on the investor's risk profile and time horizon, rather than simply moving into whichever category has either fallen the most or delivered the highest recent return and for a long-term investor, we would prefer large and mid-caps as the core allocation, with a measured exposure to small caps.

Performance of market cap based mutual fund categories in 2026 so far

Large cap segment: The analysis by ETMutualFunds further showed that there were 33 large cap funds in the said time period, of which Quant Large Cap Fund delivered the highest return of 5.95% whereas Mahindra Manulife Large Cap Fund lost the most of around 6.56% in the same time period.

Nifty 50 TRI and Nifty 100 - TRI were down 6.64% and 4.21% respectively in the same time period.

Mid cap segment: Out of 31 funds in the said time period, HSBC Midcap Fund delivered the highest return of 19.02% whereas Franklin India Mid Cap Fund gave the lowest return of 2.09% in the same period. In 2026 so far, Nifty Midcap 150 - TRI gained 6.04%.

Small cap segment: There were 33 funds in the said time period, of which Bank of India Small Cap Fund gave the highest return of around 30.09% and HDFC Small Cap Fund gave the lowest return of 1.56% in the same time period. Nifty Smallcap 250 - TRI gained 11.34% in 2026 so far.

Valuations

According to a report by Motilal Oswal Private Wealth, the Nifty is now trading at a 12-month forward Price-to-Earnings (P/E) ratio of 18.9x, which is 10% below its historical average of 21.0x. Mid and small-cap equities’ 12-month forward P/E trades at a 16%/33% premium to their 10-year averages of 24.0x/17.5x but the extent of the premium has come down compared to Sep’24.

Do large caps look attractive or can mid- and small-caps continue to outperform?

Jain said that large caps are the more comfortable place to be right now and the recent dip has done them a favour - prices have come back to levels that match their long-term averages, so an investor today is paying a fair price for the biggest, most stable businesses in the country and that's a good starting point for any investment.

“Mid- and small-caps, on the other hand, are still priced richly even after last year's fall and possibly, for some more time money flows and sentiment can stretch a rally longer than logic suggests. But the cushion is thin. If markets wobble, expensive segments fall the hardest, and smaller stocks fall harder still.”

She further said that the next phase is likely to be more selective. Large caps offer better valuation comfort and downside protection, while mid- and small caps can still outperform where earnings growth justifies their valuations. Therefore, rather than making a complete shift from one segment to another, investors should use the correction to rebalance towards large caps while retaining quality mid- and small-cap exposure.

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Anup said large caps offer superior risk-reward and valuation safety following recent corrections; mid and small caps may see near-term momentum, but elevated valuations increase downside risks.

According to equity market review and outlook by Axis Mutual Fund, large caps offer superior risk-reward and valuation safety following recent corrections. Mid and small caps may see near-term momentum, but elevated valuations increase downside risks.

Ideal allocation between market cap based funds

Anup said to allocate 50% to large caps, 30% to mid caps, and 20% to small caps as large caps currently present a far better risk-reward profile due to significant valuation comfort.

Jain said that a slightly more conservative allocation would be of around 55–60% to large caps, 25–30% to mid caps and 10–15% to small caps; investors with a higher risk appetite can increase their mid- and small-cap allocation, she said, but they should be prepared for significant drawdowns. Small-cap stocks can potentially fall 40–50% during a difficult market phase, while large caps typically experience much lower declines.

Jain said investors should focus less on how much they can potentially earn and more on how much of a fall they can tolerate without panicking.

On the risk-reward front, Jain believes large caps currently have the edge because investors are paying relatively fair prices for some of the country’s strongest businesses. Mid- and small-caps may offer faster growth, but much of that growth is already reflected in their valuations.

Another analysis by ETMutualFunds showed that small caps have outperformed mid caps and large cap funds in different horizons such as the last three months, six month, nine months, and one year.

In the last three months, where small caps gave 10.32%, mid caps and large caps gave 5.81% and 3.50% respectively. In the last one year, small cap funds gave 16.40% whereas mid caps and small caps gave 12.39% and 2.65% respectively.

The flexi cap funds have the mandate to make minimum investment in equity and equity related instruments of around 65% of total assets and have the freedom to invest across market capitalisations and sectors/themes.

Would a flexi-cap fund be a better choice now?

Jain said large caps look the steadiest today- fairly priced, with returns likely to track earnings, mid-caps remain the market's long-term sweet spot, but at current prices, what you own matters more than owning the category and small caps are still expensive, and gains there are being driven by a narrow set of stocks.

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She further said that given this, a flexi-cap fund is the smarter route for most investors right now and most investors enter a category only after its best phase is over; a flexi-cap fund removes that temptation altogether.

Anup said that large caps hold a positive, resilient outlook, while mid/small caps demand caution and flexi-cap funds are ideal now, delegating dynamic market-cap allocation to expert fund managers automatically.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)

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