Smallcap SIP returns turn negative over 3 years despite high valuations. Should investors worry?

Smallcap mutual fund investors who have been investing through systematic investment plans (SIPs) are facing a sharp slowdown in returns. Rolling three-year SIP returns for the smallcap index have fallen from nearly 40% in 2024 to the mid-single digits in 2026 and are now close to turning negative, according to a report by JioBlackRock Mutual Fund.

The report also highlighted that the decline reflects a significant deterioration in returns for investors who entered the market at elevated levels. This comes even as valuations remain high and domestic investor positioning in the segment continues to be strong.

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The report points out that previous periods of negative three-year returns, including 2008-09, 2013 and 2018-20, were accompanied by substantial valuation corrections.

In the current cycle, however, valuations have remained elevated even as returns have weakened. This divergence has made the risk-reward profile of small-cap stocks less favourable compared with that of large-cap stocks.

The report also flags strong mutual fund inflows into small-cap stocks and significant exposure to relatively illiquid stocks as potential risks.

Way ahead for smallcaps

Shivam Pathak, CFP and founder of Asset Elixir, told ETMutualFunds that the long-term outlook for small-cap funds remains positive. However, valuations call for caution, and investors should invest gradually through SIPs, maintain a long-term horizon and keep small caps as a limited part of their equity portfolio.

Jasmeet Singh, executive director at Anand Rathi Wealth Limited, told ETMutualFunds that they remain positive on the smallcap segment from a medium- to long-term perspective. “The recent market correction has helped valuations become more comfortable across market segments, with negative froth of 16 to 20%, while improving earnings momentum, especially in the broader space such as mid and small caps, with 38% earnings growth in Q1 and strong initial cues in Q2 for small-cap segments, provides a strong fundamental supportive backdrop for equities and the small-cap segment.”

However, he added that smallcaps generally tend to be more volatile and can see sharper corrections during periods of tighter liquidity and elevated global uncertainty.

Therefore, investors should not view recent performance as a reason to aggressively increase exposure or attempt to time the bottom.

“For investors with a long-term investment horizon, the current correction provides an opportunity to gradually build exposure through SIPs or staggered investments with market cap allocation of 55:23:22 across large, mid and small caps by allocating across active diversified equity funds, which helps to get exposure across segments, sectors and helps to ride across market cycles while maintaining stability & liquidity in the portfolio,” Singh further said.

Other market indicators

The report also highlights elevated leveraged exposure in the Indian equity market through the Margin Trading Facility (MTF).

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Aggregate MTF exposure increased from approximately Rs 1.1 lakh crore in late 2025 to Rs 1.49 lakh crore as of October 21, 2026. Although this was below the peak of Rs 1.58 lakh crore, the limited decline indicates that leveraged investor participation remains high.

According to the report, persistently elevated MTF exposure reflects strong investor risk appetite. However, the build-up in leveraged positions could amplify market volatility during periods of correction.

The report also notes that India's core industries recorded year-on-year growth of 7.94%, led by iron ore, electricity, coal, refinery products and cement. However, the recovery remained uneven, with fertiliser production, natural gas and crude oil registering contractions.

(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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