Run SIP with long horizon, avoid lump sum bets amid high valuations

Despite stretched valuations and market volatility, smallcap funds saw strong inflows in May as investors bank on long-term potential and return to SIPs for stability

Smallcap funds remain a preferred choice among investors despite volatility in equity markets. In May 2025, they received net inflows of ₹3,214 crore, second only to flexicap funds, which saw inflows of ₹3,841 crore, according to data from the Association of Mutual Funds in India (Amfi). 

These funds’ appeal lies in their potential to create long-term wealth.  A report by Bajaj Finserv Asset Management Company (AMC) notes that smallcap stocks saw a five-fold rise in market capitalisation, from ₹17 trillion in 2017 to ₹92 trillion by the end of 2024. 

These funds invest at least 65 per cent of their assets in smallcap stocks — defined as all listed companies beyond the top 250 by market capitalisation. As of May 31, 2025, 30 smallcap equity schemes managed ₹3.36 trillion in assets, according to Amfi. 

“The smallcap segment offers a wide array of unique and diverse business models across sectors and themes. Smallcap companies are often early-stage businesses with the flexibility to adapt to evolving market trends. This gives them room to scale revenues, improve margins, and gain market share over time. A key driver of this expansion, however, has been the emergence of new business segments and various sunrise industries,” says Sorbh Gupta, head – equity, Bajaj Finserv AMC. 

Strong return potential    

Smallcap stocks have the potential to offer high returns. “They are generally under-researched, allowing fund managers to identify undervalued opportunities before they gain broader market attention,” says Harish Krishnan, co-chief investment officer and head of equity, Aditya Birla  Sun Life AMC. 

Smallcap funds tend to perform well during broad market rallies. “Historically, this segm­ent has delivered strong long-term returns, often outperf­orming large and midcap stocks, driven by robust earnings growth and selective re-rating,” says Gupta. 

 

Fundamentals intact 

The segment’s fundamentals remain robust. “Balance sheets are clean (with low debt) and earnings growth is expected to be strong. Small and midcap SIPs have high odds of outperforming largecaps over long periods,” says Jiral Mehta, senior research analyst, FundsIndia. 

Recent rate cuts by the Reserve Bank of India could benefit smallcap companies by lowering borrowing costs and boosting demand. 

“Historically, smallcap companies tend to benefit from an easing monetary policy environment,” says Krishnan. 

Elevated valuations 

However,  valuations are stretched compared to large caps. “Currently, we are underweight on small caps due to their high valuations, very high past returns, and significant inflows,” says Mehta. Krishnan adds that investors should lower their return expectations from these funds. The segment has seen bouts of volatility, triggered by global tensions, trade disruptions, and domestic slowdowns. “Smallcap companies are often more sensitive to economic changes and market conditions, which makes them more volatile. Drawdowns can be higher compared to largecap or hybrid funds,” says Krishnan.

 

Invest gradually, stay committed 

Smallcap funds are best suited for investors with high risk tolerance and a long horizon. “These funds are ideal for investors with a high risk appetite and an investment horizon of at least five years. They still make sense for such investors due to their ability to deliver better earnings growth. They also suit individuals aiming for aggressive wealth creation, especially younger investors who can withstand market cycles,” says Krishnan. 

He adds that depending on the investment horizon, risk appetite, and prevailing market conditions, investors may allocate between 20 and 25 per cent in smallcap funds. Avoid lump-sum investments. “Continue your existing SIPs if your time frame is seven-plus years. Avoid incremental lump-sum allocation,” says Mehta.