There is a new favourite: Why midcaps are outperforming smallcaps

Smallcaps thrown off stride as regulatory hurdles and high valuations take the reins

Smallcap and midcap funds have long been investor favourites, but a shift in preference is becoming evident. Midcap funds have seen a steady increase in new investment accounts, or folios, for the past six months, with higher inflows in the past three months. This marks a contrast to the previous two years, when smallcap funds attracted greater net inflows and folio additions.

 

Industry experts link this trend to limits on new investments in many large smallcap funds. Early in 2024, most large smallcap funds halted lump sum investments and capped systematic investment plan contributions. These measures followed regulatory guidance to protect investors from liquidity risks amid strong inflows into smallcap funds. While midcap funds have faced scrutiny as well, only one fund house has introduced similar investment caps.

 

Discussions around the high valuations in both smallcap and midcap segments, along with limits on inflows, initially led to a decline in investments in these categories. However, inflows have rebounded recently, with total investments exceeding Rs 17,000 crore in the past two months. 

 

“Small and midcap schemes continue to dominate investor interest, capturing 25 per cent of total equity inflows. Midcap schemes achieved all-time high monthly inflows of Rs 4,883 crore, up from Rs 4,683 crore the previous month. Smallcap schemes also saw their highest inflows in 12 months, with Rs 4,112 crore, compared to Rs 3,772 crore the month before. It’s clear that sharp market declines are being viewed as buying opportunities by both high-net-worth individuals and retail investors, who remain keen on smallcap and midcap schemes,” Nuvama Alternative & Quantitative Research said in a report.

 

The inflows into these categories are largely driven by their strong performance across time frames.

 

“Mid and smallcap funds, as well as categories with significant exposure to this space, continue to receive strong inflows, highlighting investor preference for this segment driven by the high returns they have generated in recent years. However, investors should be mindful of the risks inherent in these segments and invest judiciously based on their risk tolerance,” said Himanshu Srivastava, associate director of manager research at Morningstar Investment Research India.