Midcap funds outlook for 2026 hinges on earnings rebound, rate support

After a subdued 2025, midcap funds could recover in 2026 if earnings revive and rates stay supportive. Experts advise a calibrated 10-30 per cent allocation with a long-term horizon

After years of strong gains, midcap mutual funds lost momentum in 2025. Year-to-date returns of about 2.5 per cent left the category well behind largecap funds, testing investor patience. As markets look ahead to 2026, investors are grappling with a dilemma: Is this underperformance temporary, or a warning sign to temper exposure and reset expectations?

 

Why did midcap funds lag in 2025?

 

Experts attribute the underperformance to rich starting valuations and a weaker macro backdrop. At the start of the year, the Nifty Midcap index traded at a multiple of 43 times earnings, compared with about 21 times for the Nifty 50 and roughly 30 times for small caps, leaving little room for disappointment. 

“Earlier, rich valuations were supported by strong earnings growth. But in 2025, earnings per share growth slowed to high single digits from the high-teens to low-20s of the previous three years. Fiscal consolidation, weaker government spending, and soft nominal GDP growth further hurt demand, prompting investors to shift towards largecap stocks with more stable earnings and balance sheets,” says Ankit Patel, co-founder and partner at Arunasset Investment Services.

 

Can midcap funds stage a comeback in 2026?

 

A recovery in 2026 remains possible if earnings revive and interest rates stay supportive. “A recovery in midcap funds looks likely in 2026 if earnings improve and rates stay supportive. Easing inflation, lower borrowing costs, and a rebound in margins — led by financials, autos, and manufacturing — could lift performance. Improving rural demand may aid consumption plays,” says Akshat Garg, head of research and product, Choice Wealth.

 

Patel expects any recovery to be driven by earnings rather than valuation expansion. “Valuations have eased, with the Nifty Midcap trading near 33 times earnings — close to its five-year average — unlike early 2025 when prices were stretched. A more growth-supportive policy environment, along with a likely pickup in nominal GDP growth, should aid midcap earnings,” he says.

 

What are the key headwinds to watch?

 

The pace of demand recovery will shape performance in 2026. “If consumption and investment fail to pick up, earnings growth could remain weak, with midcaps feeling the impact more due to higher operating leverage. External risks such as a US slowdown, trade tensions, tighter global financial conditions, rising input costs, delayed capex, and execution challenges could also limit the recovery,” says Patel.

 

How expensive are midcaps now?

 

At the end of 2025, the Nifty Midcap 150 trades near 33 times earnings and 4.5–5 times book value, with a sub-1 per cent dividend yield, still higher than large caps. “With one-year returns of just 5–6 per cent, earnings have lagged the earlier rerating, making stock selection, balance-sheet strength, and management quality more important than index-level gains in 2026,” says Ram Medury, founder and chief executive officer, Maxiom Wealth.

 

What is the ideal allocation to midcap funds?

 

Given these conditions, fund managers advise conservative investors to cap midcap exposure at 10–15 per cent of their equity portfolio, alongside large caps and debt. Medury says moderately aggressive investors can allocate 20–25 per cent of their equity portfolio, while aggressive investors with an eight- to 10-year horizon may consider about 30 per cent of the equity portfolio, with adequate diversification.

 

What is the outlook for 2026?

 

Experts remain guarded but positive on midcap funds in 2026 and urge investors to moderate expectations. “With earnings stabilising and policy support improving, quality stocks with strong balance sheets, pricing power, and cash flows are best placed to benefit. For investors, disciplined exposure through diversified or quality-focused funds, rather than momentum chasing, may deliver steady returns over the next two to three years,” says Garg. 

 

The writer is a Delhi-based independent journalist.