Midcap and smallcap funds: Continue SIPs despite recent anaemic performance

Maintain allocation to these higher-growth segments because of their potential to offer superior returns over the long term

Midcap fund inflows fell 25 per cent year-on-year in October to ₹3,807 crore, while smallcap fund inflows dropped 20 per cent to ₹3,476 crore. After two strong years in 2023 and 2024, returns have been subdued this year. Experts say long-term investors should remain patient and stay invested through the current phase.

 

Why have flows slowed? 

Net inflows across equity categories declined in October, with open-ended equity inflows falling 19 per cent month-on-month. Largecap funds saw a 58 per cent decline and multicap funds 30 per cent.

 

“The decline in flows is part of a broader market-wide moderation in inflows into equities. It does not reflect a shift in sentiment against mid- and smallcap funds specifically,” says Piyush Gupta, director – financial services, Crisil Intelligence. 

Profit booking by lump-sum investors and allocation to other assets have contributed to reduced flows. “Inflows via systematic investment plan (SIP) remain steady. Lump-sum investors may be booking profits and shifting their money to gold and multi-asset funds that have done well this year. Anecdotal evidence also suggests that many people are taking money out of financial assets and using it to invest in real estate,” says Sandeep Bagla, chief executive officer, Trust Mutual Fund. He adds that high valuations and economic sluggishness may have also played a role. 

Exposure to faster-growing segments 

Many fast-expanding sectors and newly listed companies fall in the mid- and smallcap universe. Infrastructure, for instance, has only a handful of largecap stocks but around 70 in mid- and small caps. “By restricting themselves to large caps, investors would miss out on this growth,” says Bagla.

 

Such exposure can diversify portfolios. “By holding these funds over a longer horizon, investors can generate higher returns and build wealth,” says Gupta.

 

Volatility and liquidity risk 

Mid- and smallcap funds are riskier than their largecap counterparts. “One risk is that of higher volatility, which can lead to sharper drawdowns during corrections,” says Aditya Agarwal, co-founder, Wealthy.in. Lower liquidity makes it harder for fund managers to execute large trades without price impact.

 

Earnings tend to be less stable. “Factors like macroeconomic conditions, competition from larger players, or overreliance on a few large customers can severely impact their profitability,” says Nilesh D Naik, head of investment products, Share.Market. He adds that smaller businesses may lack strong governance structures.

 

Investors must bear in mind that midcap funds, which invest in stocks ranked between 101 and 250 (businesses above ₹30,000 crore market cap), tend to be less risky than smallcap funds.

 

Enter with long horizon 

Investors with at least two to three years of market experience may enter these funds, but with a longer horizon due to their elevated valuations (relative to large caps).

 

“The investment horizon for midcap and smallcap funds should be at least five to seven years as the probability of negative outcomes diminishes sharply with a longer holding period,” says Gupta. He cites five-year rolling returns data with daily shifts over 15 years ending October 2025, which showed that returns were above 10 per cent in around 92 per cent of observations.

 

Bagla says investors should allocate only that part of their portfolio in which they can tolerate high volatility.

 

Decide allocation 

Investors must set clear exposure limits before investing. “All investment or redemption decisions should be guided by this framework and not by greed or fear,” says Naik.

 

Agarwal recommends investing via SIPs instead of lump sums at this stage. He suggests allocating 15–30 per cent of the equity portfolio to these funds as part of the satellite allocation. Naik cautions that even high-risk investors should not allocate more than 20 per cent to smallcap funds.

 

Choose funds with a long track record and strong risk-adjusted returns. Understand the fund manager’s investment approach and avoid decisions based solely on recent performance.

 

Continue SIPs 

SIPs benefit from lower prices during downturns. “Stopping now would defeat the core purpose of an SIP, which is to average out the purchase cost over market cycles,” says Agarwal. He adds that long-term investors should treat underperformance relative to large caps as a buying opportunity.

 

Existing investors should ensure their allocation stays aligned with their target mix. “If allocation to a particular fund category is higher than the pre-decided level, investors may consider stopping SIPs there,” says Naik.

 

Finally, prefer active funds in this space. “Unlike largecap funds where returns often track the index, a skilled mid- or smallcap fund manager can generate significant alpha through superior stock selection, especially during downturns,” says Agarwal.