The small-cap mutual fund category has demonstrated high volatility over the past nine months, characterised by two distinct phases: a substantial correction from September 2024 to March 2025, followed by a robust recovery between March and June 2025.
Following outstanding performance in early 2024, small-cap funds faced a comprehensive correction starting in late September 2024 that persisted until early March 2025. The small-cap category suffered the steepest decline at 22 per cent, compared to mid-cap (20 per cent), multi-cap (19 per cent) and large-cap (17 per cent) funds.
Navigating the drawdown
The downturn stemmed from elevated valuations and persistent foreign institutional investor selling resulting from economic slowdown concerns. Small-caps experienced amplified losses due to risk-averse sentiment that drove investors from high-risk assets toward safer alternatives. Mahindra Manulife Small Cap recorded the largest decline at 26 per cent, while HSBC Small Cap and Bank of India Small Cap fell 25.6 per cent and 25 per cent respectively. Meanwhile, Motilal Oswal Small Cap (-17 per cent), Quantum Small Cap (-17.4 per cent), and Axis Small Cap (-19.7 per cent) managed to contain the loss relatively well in the category.
The correction disproportionately affected capital goods, PSU and real estate sectors, with BSE Power (-34 per cent), BSE Utilities (-33 per cent), BSE Realty (-30 per cent), NIFTY PSE (-28 per cent) and Nifty EV and New Age Automotive (-27 per cent) experiencing severe declines. Among top holdings in small-cap schemes, HFCL, Power Mech Projects, Restaurant Brands Asia, TVS Holdings and SH Kelkar plummeted 43-48 per cent. However, Shaily Engineering Plastics, Acutaas Chemicals, Narayana Hrudayalaya, PG Electroplast and Wockhardt defied the trend with positive returns of 23-47 per cent.
Recovery dynamics
Recovery commenced on March 4 for Nifty 50 and large-cap indices, while Nifty Smallcap 250 bottomed earlier on February 28. Compelling valuations, robust domestic institutional flows, and India’s improving economic fundamentals—including strong GDP growth and earnings resilience—fuelled the rebound. The Nifty Smallcap 250’s PE multiple compressed to 26 from September 2024’s 32 level.
Small-caps demonstrated superior recovery momentum, generating 22 per cent returns compared to mid-cap (21 per cent), flexi-cap (16 per cent) and large-cap (15 per cent) fund categories. Nifty India Defence, Nifty Capital Markets, Nifty MidSmall Financial Services, BSE Industrials, BSE Realty and BSE Capital Goods staged dramatic recoveries with returns of 29-72 per cent.
Quality-focused small-cap schemes outperformed. DSP Small Cap, ITI Small Cap, Bandhan Small Cap and Aditya Birla SL Small Cap led performance with gains of 25.4 per cent, 25 per cent, 24.5 per cent and 24.4 per cent respectively from February 28 to June 11. Within top holdings, Lumax Auto Technologies, Paradeep Phosphates, Solar Industries India, Carysil and Bharat Dynamics delivered exceptional returns of 80-107 per cent.
Portfolio analysis and AMFI data from September 2024 reveal several noteworthy trends.
Rising Investor Interest: Small-cap fund folios surged 29 lakh to 2.5 crore between September 2024 and May 2025, mirroring trends across equity categories. Risk-seeking retail investors are propelling this growth, attracted by the large recent returns. However, small-cap allocations should align with the individual’s risk profile.
Shift toward micro-caps: Micro-cap allocation within small-cap fund portfolios expanded by 2 percentage points to 32 per cent from September 2024. Current category average allocations stand at 7 per cent for large-cap, mid-cap (12 per cent) and small-cap (48 per cent) as of May. LIC MF Small Cap (56 per cent), Tata Small Cap (53 per cent) and DSP Small Cap (53 per cent) maintain the highest micro-cap exposure. Popular micro-cap holdings include Equitas Small Finance Bank, JK Lakshmi Cement, Kirloskar Pneumatic Company, Rolex Rings and TeamLease Services, held by at least 10 small-cap funds.
Broadening the Stock universe: The biggest funds in the category navigated this period by expanding their holdings. Nippon India Small Cap, with assets of ₹63,007 crore, added 18 stocks to reach 237 holdings. Quant Small Cap (AUM of ₹28,205 crore) incorporated 20 new positions totalling 92, Bandhan Small Cap (₹11,743 crore) added 17 to reach 187 and SBI Small Cap (₹34,028 crore) included six additional stocks for 63 total holdings.
Despite market turbulence, small-cap funds attracted net inflows of ₹36,372 crore from September 2024 to May 2025, compelling fund managers to expand their portfolios. While diversification offers benefits, excessive stock additions risk creating index-like portfolios that may compromise alpha.