The Indian mutual fund market continues to see strong interest in mid-cap and small-cap funds. Despite volatility and high valuations, money from investors is flowing into these categories. Meanwhile, large-cap funds are seeing outflows. This shows the changing preferences of investors in the market.
Let us understand why investors are being attracted to these funds and what they should keep in mind going forward.
What’s Happening?
According to AMFI data for July 2026, small-cap mutual funds received the highest net inflow of Rs 7,767.50 crore. Mid-cap funds saw a net inflow of Rs 6,192.31 crore. Meanwhile, large-cap funds witnessed an outflow of Rs 1,321.69 crore. Multi-cap funds also recorded a net inflow of Rs 3,227 crore.
These figures indicate that investors are showing greater interest in growth-oriented segments. In the past six months, small-cap mutual funds delivered an average return of nearly 21.26%, which was better than other domestic equity categories and international funds.
Bank of India Small Cap Fund delivered a return of approximately 35.02% during this period. Trust MF Small Cap Fund gave 31.27%, while Nippon India Small Cap Fund delivered a return of 16.55%. On the other hand, HDFC Small Cap Fund recorded the lowest return of around 6.81%. Mid-cap funds delivered an average return of 10.74%.
Why Does the Interest Continue?
Strong earnings growth and rising opportunities in the economy are the key reasons behind investors’ interest. According to Motilal Oswal Financial Services’ Nifty 500 review, Nifty Smallcap 250 companies recorded 35% YoY earnings growth in Q1FY27.
In small-cap stocks (excluding oil and gas), year-on-year earnings growth exceeded 30%. Experts like Rajesh Minocha say that this surge is a recovery after the earlier decline. Improved investor sentiment, domestic liquidity and selective stock picking also contributed to it.
New sectors such as defence, aerospace, electronics, semiconductors, renewable energy and electric vehicles have increased opportunities in the mid and small-cap space. Younger investors are being attracted to these funds due to their long-term investment horizons and ability to take on higher risk. As a result, the share of mid-cap funds in net flows has risen from 14% in FY23 to nearly 20% YTD.
Valuation Concerns and Performance Comparison
Concerns around valuations persist. Nifty’s 12-month forward P/E is at 18.9x, which is 10% below its historical average of 21.0x. Mid and small-cap equities are trading at a 16% and 33% premium, respectively, to their 10-year averages of 24.0x/17.5x. However, this premium has reduced compared to September 2024.
The one-year forward P/E of Nifty Smallcap 250 is at 28.2x, and small-caps are trading at a premium to both their 5-year and 10-year averages. In the past six months, pharma and healthcare funds delivered an average return of 19.11%. Meanwhile, flexi-cap funds gave a 6.20% return, while large-caps declined by 0.07%.
What Does This Mean for Investors?
Amid rising interest in mid-cap and small-cap funds, allocation is important. For most investors, small-cap exposure is recommended to remain within 20-25% of total equity allocation.
For those who missed the recent rally, there is an option to increase exposure in a staggered manner over the next 6-12 months. Existing investors can continue their SIPs and rebalance if their allocation increases.
For goals of 2-5 years, large-caps are generally preferred, while for investment horizons of 7-10 years or more, mid-caps may be considered. Investors with a very long-term horizon and higher risk-taking capacity can also consider small-caps.
It is important to avoid chasing past returns. SIPs benefit from rupee-cost averaging and compounding, while frequent switching of funds can impact compounding.
What’s Next?
The future direction will depend on company results, economic growth, domestic liquidity, interest rates and investor confidence. Earnings growth will remain the main driver, while input costs may also have an impact.
According to Motilal Oswal Private Wealth, mid and small-caps are benefiting from strong earnings growth and a supportive domestic backdrop. Their model allocation comprises 40% hybrid/large caps, 10% global equities and 50% mid and small caps.
Aspects such as sharp market corrections, FOMO and portfolio review will also remain important going forward. Overall, this trend reflects investors’ interest in the growth potential of mid and small-caps.
Disclaimer: This article is for educational and informational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. The companies mentioned are cited as examples within the context of market developments. Investors are advised to conduct their own due diligence and consult their financial advisor before making any investment decisions.
Investments in the securities market are subject to market risks. Read all related documents carefully before investing.
