Smallcap mutual funds lead rally with 10% gains in 1 month. A short-term bounce or start of a sustained rally?

Small cap mutual funds have emerged as the top-performing segment over the last one month as they were the only category to deliver double-digit returns of around 10%, significantly outperforming both mid and large caps raising key questions for investors—whether this is the beginning of a sustained rally or just a temporary bounce.

Market experts believe that this is a sharp rally following the correction rather than a sustained rally or a long-term upward trend and continued SIP inflows might have supported this outperformance in this segment.

Rajesh Minocha, a Certified Financial Planner (CFP) and Founder of Financial Radiance, told ETMutualFunds that this situation reflects a sharp recovery following a correction, rather than the start of a long-term upward trend and improved market liquidity, increased risk appetite, and earnings stability have driven this movement.


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Often, it is investors’ greed that drives such a rally, investments are made based on what’s hot in the market rather than based on one's own risk appetite and goals and investors need to be very wary of such situations, Minocha further said.

Another expert, Pallav Agarwal, Certified Financial Planner at Bhava Services LLP, shared with ETMutualFunds that the BSE Small cap 250 index fell nearly 25% from late 2024 to early 2026, with its recent rebound looks likely to be a short-term mean reversion rather than a sustainable rally due to high valuations.

Agarwal further said that continued SIP inflows might have supported outperformance in the small cap segment through increased liquidity.

In the last one month, small cap funds gave an average return of 10.05%. There were 35 funds in the category who have completed one month of existence in the market. Out of these 35 funds, Bank of India Small Cap Fund gave the highest return of around 15.11%, followed by Sundaram Small Cap Fund and LIC MF Small Cap Fund who posted a return of 12.79% and 12.27% respectively in the last one month.

HDFC Small Cap Fund and PGIM India Small Cap Fund were the last ones in the list who gave returns of around 7.93% and 7.84% respectively in the last one month.

Based on the monthly returns since January 2026, small cap funds have been in the negative territory in January and March where these funds gave a negative average return of 4.44% and 8.88% respectively. In February, the small cap funds gave an average return of 1.50% and in April till now, these funds have posted an average return of 13.53%. (Source: ACE MF)

In the calendar year 2026 so far, small cap funds witnessed a marginal dip of 0.13% with Bank of India Small Cap Fund being the biggest gainer as the fund posted a return of 5.95% whereas Tata Small Cap Fund lost the most at around 5.40%.

Invest now or wait for correction?

With returns turning attractive in a short span, many investors are wondering whether to enter small caps now or wait for better valuations.

Agarwal said investors who have a very long-term time horizon of at least 7-8 years or more might invest in small caps preferably through SIPs or in staggered manner through lumpsum purchases also on corrections.

To this, Minocha said market sentiment drives small-cap stock movements, creating patterns that are not evident in just one month of trading and investors should avoid chasing short-term 10% price changes, as this rarely leads to success.

Minocha further said that it is advisable to stagger investments through SIP or STP rather than investing a lumpsum; attempting to time the perfect market dip often results in missed opportunities; valuations, once affordable, have now become expensive and as a result, risks have increased due to several factors.

According to an equity view by Tata Mutual Fund, Nifty is now trading at a reasonable PE of 20x and with earnings growth of 15-17% visible next financial year which sets the tone for better equity returns in next 12-18 months, midcap and small cap premium has come down but risk reward and flows will still favor large caps more.

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The report further said that the headline valuation premium for Nifty Smallcap 100 vs Nifty 50 has come down further to 12% by the end of March 2026 from the highs of nearly 21% in June 2025.

“Nifty Smallcap 100 1-year forward P/E remained at 19.8, higher than the long-term average of 16.9x. Valuations continue to remain expensive. Hence, while the index has corrected, valuations continue to remain expensive,” the report by Tata Mutual Fund further said.

Are valuations stretched again? What about risks?

Aditya Khemani, Fund Manager-Equity at Invesco Mutual Fund told ETNow that the last couple of years have been a consolidation phase for the SMID space, during this period, a large part of the froth has corrected, and earnings expectations have moved closer to reality and as a result, the segment appears well positioned from a long-term perspective.

Minocha said that earnings visibility remains unpredictable, as liquidity-driven market gains can reverse quickly and small-cap stocks are prone to sharper declines than their previous gains.

Agarwal said that the valuations have again become stretched, and any investment should only be done with a very long-term time horizon and the risk in small caps is higher as compared to the other categories precisely due to the recent outperformance.

Small caps vs mid and large caps: Where is the better risk-reward?

At current levels, the report by Tata Mutual Fund further said that risk-reward is more in favour of large caps and selective exposure to mid and small caps in favoured sectors.

Agarwal had a similar opinion. He said that Large caps look more attractive on risk-reward ratio as compared to small cap and even midcap category primarily because of reasonable valuations.

Historical performance

Small cap mutual funds got the tag of worst performers of 2025 as the category on an average lost 4.62%. There were 29 funds in the category in the said time period, of which 27 gave negative returns and two gave positive returns.

An analysis by ETMutualFunds showed that in the last three months, small cap mutual funds have offered the highest average returns of around 2.59% and in the last one year, the category has offered the second highest average return of around 8.74% and remained at the same position in the three year chart with an average return of 19.61%.

In the last five years, these small cap mutual funds gave the highest average return of around 19.35%.

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Outlook for small caps

Khemani said that from a long-term standpoint, the small-cap segment remains attractive. However, investors should have a minimum investment horizon of five to seven years when allocating to the small-cap category.

Agarwal said that funds with robust selection criteria, effective cash management during periods of volatility, and a demonstrated history of performance are likely to maintain their performance and the market will favour stocks that report strong earnings and provide positive future growth guidance.

Minocha said that small-cap stocks will experience short-term price swings, but their future performance remains strong only if one plans to stay invested for more than 10 years and does not want to invest based on short-term price movements and is looking to make quick money.

For most investors, they should continue to get small-cap exposure through funds like flexi-cap funds, where a competent fund manager buys small caps when needed, or through multi-cap funds, which provide a minimum of forced small-cap exposure and only small-cap exposure should be limited to a very small portfolio of overall asset allocation, and only if it is really needed and one has the risk appetite, Minocha said.

According to the equity outlook by Bajaj Finserv AMC, Sorbh Gupta, Head – Equity said that in this environment, large-cap equities offer valuation comfort and relative stability in volatile conditions.

At the same time, multi-asset strategies can act as effective shock absorbers amid geopolitical and commodity-driven uncertainty. Meanwhile, for small cap exposure, a disciplined SIP approach is recommended to navigate near-term volatility, Gupta further said.

(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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