Investing in small and mid caps? DSP Mutual Fund recommends SIPs or experienced fund managers

Investors looking to invest in small- and midcap stocks should consider the systematic investment plan (SIP) route or choose a fund manager with experience navigating market cycles over the past two decades, according to a report by DSP Mutual Fund.

The fund house advises investors to focus on oversold and undervalued stocks rather than chase recent outperformers, adding that large-cap stocks currently offer more attractive opportunities than small- and midcaps (SMIDs).

“For Small and Mid caps (SMIDs), follow the SIP route or choose a manager who has seen all the cycles over the past two decades. The focus should be on what part of the market offers oversold and undervalued names. You are more likely to find them in large caps than SMIDs,” said the fund house.


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DSP Mutual Fund’s analysis comes at a time when the largecap stocks and small- and midcap stocks are moving in different directions. Some largecap stocks are now available at prices similar to those seen during past market crashes, while small- and mid-cap stocks remain expensive even though their recent returns have slowed.

Largecaps have corrected enough for valuations to enter fair-to-cheap territory, while SMIDs have seen less valuation compression and need stronger earnings growth to justify broad-based exposure, the report said.

The fund house noted that largecap stocks are now witnessing oversold price readings. The Nifty index recorded eight consecutive weekly declines through September 2026, following four consecutive months of losses through March 2026. The lows recorded during the two periods were within 3% of each other, underscoring the persistence of market weakness.

Large caps offer more attractive valuations than SMIDs

According to DSP Mutual Fund, the current market presents a significant valuation gap between large caps and smaller companies as SMIDs are trading at full-blown bull market multiples while several large caps are trading near decade lows.

Defensive sectors dominated by large-cap businesses, including private banks, information technology and consumer staples, have underperformed cyclical sectors such as metals, power, public sector banks and industrials.

The fund house observed that several large-cap companies with high return on equity and strong business fundamentals are trading at valuation multiples similar to those of cyclical businesses. Such a situation was last seen in 2007, following the capital expenditure boom. Some large-cap stocks are now trading at valuations comparable to those seen during the Covid-19 market decline or the 2008 global financial crisis.

Some opportunities are too good to miss. Yet there are pockets which appear to be a no-go zone, the fund house further said.

Largecap stocks are also trading near the 10th decile of their five-year rolling compound annual growth rate (CAGR) distribution. Historical data cited by DSP Mutual Fund indicates that when the Nifty 100’s trailing five-year CAGR was in its lowest decile, the index delivered an average annualised return of 15.5% over the subsequent five years.

The fund house said the Nifty was trading below 19 times trailing earnings and at around 2.8 times price-to-book value at the end of September 2026, based on its assessment of the market. Excluding the Covid-19 decline, it believes largecap valuations have rarely been this attractive in more than a decade.

Cautious about small and mid caps

DSP Mutual Fund cautioned that small- and mid-cap stocks have significantly outperformed large caps over the recent bull-market cycle, pushing their relative valuations to elevated levels. Historically, these segments have tended to lose much of their outperformance during market downturns because their higher volatility can lead to deeper drawdowns.

The fund house’s analysis shows that small- and mid-cap lose almost all the alpha generated during the upcycle and this is consistent with the volatility readings for SMIDs, where the higher volatility results in deeper drawdowns and crashes during bear markets compared to the relatively shallower declines in large caps.

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According to the report, small and mid caps currently have a substantial performance advantage over large caps. DSP Mutual Fund believes investors may be better served by increasing their focus on large-cap stocks until valuations and relative performance across market segments become more balanced.

“To capture the extra alpha offered by the small and mid-cap segments, investors are better off focusing on the margin of safety rather than relying on recent outperformance. In fact, it makes enormous sense to be aggressive in SMIDs when their alpha over large caps has vanished,” said the fund house.

At present, SMIDs have a large alpha over large caps, so investors might be better served by focusing more on large caps as a relatively better option.

The valuation divergence is also visible in the relative performance of the indices. As of September 2026, the BSE SmallCap-to-Sensex and BSE MidCap-to-Sensex ratios were approximately 72% and 56% above their historical medians, respectively. Both were around three standard deviations above their long-term averages.

Over the preceding year, small caps outperformed the Sensex by 21.5%, while mid caps outperformed it by 14.1%. In contrast, the Nifty Top 10 Equal Weight Index underperformed the Nifty 500 by around 10.6%.

DSP Mutual Fund noted that previous peaks in the relative performance of small and mid caps—in 2007, 2010 and 2017—were followed by periods of mean reversion. The median relative decline over the subsequent 24 months was around 30% for small caps and 21% for mid caps. While history does not guarantee an immediate reversal, the fund house believes the current divergence warrants caution and SMIDs now need extraordinary fundamentals to sustain extraordinary relative returns and large caps need only some normalisation of today's unusually wide gap.

(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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