Gold up 65%, Small-Caps down 7.5%: Where investors should invest in 2026

2026 Investing Guide: smallcase managers flag risks, opportunities and sectors to track

As investors step into 2026, smallcase managers say the single biggest learning from 2025 is clear: high valuations demand caution, not complacency, and markets reward selectivity over momentum. After a year of wildly divergent asset-class returns, record domestic liquidity, and sharp valuation resets in smaller stocks, fund managers argue that 2026 will be a year defined by realistic expectations, disciplined stock-picking and long-term conviction rather than index-chasing.

 

What 2025 taught investors:

 

The year 2025 was a study in contrasts. Benchmark indices hovered near record highs; yet under the surface, broader markets struggled.

 

Large-caps delivered a steady 8% YTD, with valuations holding near 22x, signalling stability and earnings-led growth.

 

 

Mid-caps returned only 3% YTD, while valuations sharply corrected from 43x → 33x.

 

Small-caps fell 7.5% YTD, accompanied by valuation compression from 34x → 28x.

 

Across asset classes, the divergence was even more striking:

 

Gold surged 65% YTD, becoming the best-performing major asset class—buoyed by geopolitical risk, a weaker rupee and safe-haven flows.

 

MSCI Emerging Markets delivered 30%, beating developed markets.

 

In the US, the Nasdaq gained 22%, S&P 500 rose 17%, and Europe returned 16%.

 

China edged up 14%, reversing part of a multi-year decline.

 

India’s BSE 500 returned only 4%, underperforming global peers.

 

Foreign investors were major sellers, pulling out ₹1.55 lakh crore from Indian equities in 2025—one of the largest annual outflows in years—triggered by high US rates, a strong dollar and political noise around America-first trade policies.

 

But domestic investors held the market together.

 

DIIs bought ₹19,783 crore in November alone.

 

SIP flows hit a record ₹29,529 crore in October 2025.

 

Monthly SIP averages hovered near ₹30,000 crore, creating a structural liquidity base that cushioned volatility.

 

The message: India’s markets remain global-sentiment sensitive but domestically resilient.

 

Is valuation still a concern?

According to managers, the market continues to trade at elevated valuations, with nearly 80% of listed stocks currently in the overvalued zone. While strong earnings growth can gradually justify these valuations, investors should be mindful that expensive markets are more vulnerable to sudden “black swan” risks.

 

Historically, short-term returns are harder to generate when valuations are stretched, whereas long-term investing remains far more reliable. Staying invested over a 10-year horizon has consistently delivered better and more predictable outcomes, reinforcing the need for patience and discipline.

 

 " The market, as a whole, is expensive—but that doesn’t mean there are no opportunities. In fact, these are the kinds of markets where patient, long-term investors tend to do better than those chasing quick gains," said Nikhil Gangil, smallcase manager, Founder and CIO, Intrinsic Value.

 

2026: What Investors Should Focus On

 

According to smallcase managers, 2026 won’t be a year to chase what worked last year. It will be a year to stay disciplined while leaning into India’s structural growth story.

 

1. Accept that markets are expensive—nearly 80% of stocks are overvalued

 

Managers warn that valuations remain stretched across most segments.

 

High valuations don’t mean a crash—but they do mean lower odds of short-term outsized returns. Long-term returns, however, remain robust for investors who stay invested through cycles.

 

2. India’s long-term outlook remains strong: 6–7% real GDP growth expected

 

Managers remain bullish on fundamentals:

 

• Moderating inflation approaching 4%
• Onset of a rate-cut cycle
• Policy push in manufacturing, infra and exports
• Rising productivity and rapid urbanisation

 

3. Watch for the big shift: from public capex → private capex revival

 

After two years of government-led spending, managers expect corporate balance sheets to drive the next leg of growth.

“We remain bullish on Indian equities in 2026, with a clear focus on stock selection rather than index levels. While public capex has driven growth so far, the next phase will come from a revival in private capex as corporate balance sheets strengthen and capacity utilisation rises, setting up the next leg of India’s structural growth. Our bottom-up view is anchored on chemicals, infrastructure and manufacturing—sectors that combine policy support with a cyclical recovery," said Dhiren Shah, smallcase manager, Co-Founder, Kamayakya.

 

4. Prepare for global volatility—but don’t fear it

 

Trump-related tariff risks, geopolitical tensions, and US tech concentration can temporarily shake EM flows.

 

"Tariff-related noise from the US, particularly around a potential Trump return, is more of a sentiment and liquidity risk for India than a structural one. It can tighten global liquidity, lift volatility and lead to temporary FII outflows, but it does not change India’s core growth story. At the same time, the AI-led surge in a few US mega-cap stocks has pulled a disproportionate share of global capital, leaving emerging markets under-owned despite stable fundamentals. This has made Indian markets more vulnerable to short-term, flow-driven swings, even as domestic growth and earnings remain on a solid footing," said Vivek Sharma, smallcase manager, Investment Head, Estee Advisors 

 

Managers expect that once US growth moderates and the Fed pivots, capital should return to EMs, with India remaining the standout beneficiary.

 

5. Don’t chase hot sectors; focus on valuation discipline

 

Managers warn against herd behaviour.

Even high-quality companies deliver weak returns if bought at inflated prices.

 

They recommend:

 

• Avoiding crowded trades
• Analysing earnings durability
• Prioritising balance-sheet strength
• Following a wait-for-value approach

 

Interestingly, despite froth in broader markets, the SME segment appears better valued than large swathes of the main board.

Undervalued pockets exist in printing, paper, jute, media, oil and banking.

 

6. Diversify across asset classes, styles and sectors

 

Given heightened valuation risk, diversification becomes essential—not optional.

 

Managers stress that investors should build:

 

• A balanced equity portfolio (large, mid, selective small)
• Exposure to gold, given its 2025 performance and macro backdrop
• A fixed income allocation aligned with easing interest rates
• A style mix (growth + value + quality)

 

Investment success, they argue, must be measured not against peers but against personal goals and risk capacity.

 

Outlook: Cautious Near Term, Confident Long Term

 

As India heads into 2026:

 

• Macro fundamentals remain strong
• Inflation is moderating
• Private capex cycle looks set to turn
• Domestic liquidity is robust
• Earnings durability is improving
• But markets are no longer cheap.

 

That means investors must enter 2026 with realistic expectations, higher selectivity, and a longer time horizon—while still recognising that India remains one of the world’s strongest structural growth stories.

 

"Chasing popular narratives or crowded trades often leads to underperformance, with investors entering themes after valuations have already peaked.

 

The managers call for investors to have a well-diversified portfolio across asset classes, styles and sectors to navigate volatility and compound wealth steadily over time. They note that investment success should be measured against one’s own goals and risk appetite, not against others who operate under very different constraints," noted the Smallcase report.