Are smallcap mutual funds losing shine? Returns dip sharply up to 18% in 2025

Economic Times

07-05-2025

Small cap mutual funds experienced a significant downturn in 2025, with returns dipping sharply, some funds losing up to 18%. This underperformance is attributed to stretched valuations, global uncertainties, and domestic elections. Despite recent losses, experts suggest long-term investors may still benefit, viewing corrections as potential buying opportunities, especially given the superior earnings growth potential of small caps.
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Smallcap mutual funds have offered a negative return of up to 18% in 2025 so far and on an average have lost 11.72% in the same period. There were around 29 small cap funds in the current calendar year so far.Out of 29 funds in the category, 22 funds lost in double-digits. LIC MF Small Cap Fund lost the most at around 17.75% in the current calendar year so far, followed by HSBC Small Cap Fund which lost 16.45% in the same period. Motilal Oswal Small Cap Fund delivered a negative return of 15.16% in 2025 so far.Kotak Small Cap Fund has lost 12.83% in the same time period. Nippon India Small Cap Fund , the largest small cap fund based on assets managed, gave a negative return of 10.85% in the mentioned time period. Quant Small Cap Fund lost the lowest of around 7.72% in the said time period.The market experts attribute this underperformance to stretched valuations and uncertainties around global interest rates, geopolitical developments, and domestic elections added to the overall volatility.'In 2025, small cap funds in India witnessed a sharp correction following a period of strong performance. One of the primary reasons was stretched valuations—price-to-earnings ratios had moved well above historical averages, comparable to levels seen during 2007–08. This led to profit booking as investors who had seen high returns in 2023 and 2024 began exiting their positions. Regulatory bodies like SEBI and AMFI also issued cautionary statements regarding froth in the small cap space, prompting some fund houses to pause or limit new investments,' said Chakravarthy V, co-founder and Executive Director of Prime Wealth FinservAnother expert shares the performance of small cap funds over a longer period and explains that this stellar performance was backed by superior earning growth of small caps.'After a stellar run of four years, which saw huge performance by small caps, it is not surprising to see a correction and consolidation in terms of time and price for the small cap stocks. The run of the last five years has been backed by superior earnings growth of small caps and we expect small cap earnings growth to continue to be better than that of last caps in the next two years,' said Mihir Vora, CIO of Trust Mutual Fund The small cap funds are benchmarked against Nifty Smallcap 250 - TRI and BSE 250 Small Cap - TRI which went down by 12.44% and respectively in the current calendar year so far.On an average these benchmarks lost 11.69% in the same time period, denoting a marginal outperformance against funds average loss.With small cap funds offering negative returns up to 18%, the experts believe that the concern among the small cap investors depends on multiple factors such as the investor's entry point, time horizon, and risk perception.Chakravarthy V said that, 'Those with a recent entry may see negative returns, while others with longer holding periods may view the correction differently. The situation highlights the cyclical nature of small caps, where sharp rallies are often followed by equally sharp corrections. The impact of such events varies depending on the individual investment context and goals.'On the other hand, Vora of Trust Mutual Fund says that the great part about small caps is that there is a wide variety and large number of stocks to choose from and there are over 800 stocks in this small cap space out of which over 500 are in segments that we consider as high growth segments. 'So an investor, looking to invest in segments with superior growth will naturally have to veer towards small caps for stock picking,' he added.ETMutualFunds further analysed the data of small cap funds in previous calendar years. The deep dive in the data showed that since calendar year 2022, out of 24 small caps, 13 funds have not offered negative returns in the calendar year 2022, 2023, and 2024.The other small caps have offered negative returns in 2022 only and delivered gains in 2023 and 2024. The schemes that have offered positive returns in all the last three calendar years includes Axis Small Cap Fund, Canara Robeco Small Cap Fund, DSP Small Cap Fund, Edelweiss Small Cap Fund, HDFC Small Cap Fund, Nippon India Small Cap Fund, Quant Small Cap Fund, and SBI Small Cap Fund.Small cap funds gave a marginal loss in 2022 and gave gains in 2023 and 2024 raising a concern that whether small cap investors are still making money or not? While addressing this concern, Chakravarthy V said that investor outcomes in small caps have varied based on timing as those who started investing before 2022, particularly through systematic plans, may still be in profit due to the gains accumulated during the multi-year rally.'On the other hand, investors who entered in late 2024 or early 2025 are more likely experiencing negative returns due to the recent correction. This divergence illustrates how the timing of investment plays a significant role in performance,' he added.BSE 250 Small Cap - TRI had been in the red since the last nine months. In the last nine months, the index went down by 6.57% whereas in the last six months it dropped by 10.46%. In the last three months, it lost 1.29%.The other index - Nifty Smallcap 250 - TRI went down 7.98% in the last nine months and dropped by 12.09% in the last six months. In the last three months, this index went down by 3.51%.Commenting on whether investors should use this correction as an opportunity to buy more or should stay cautious, Chakravarthy adds that some market participants view corrections as opportunities, especially when valuations become more reasonable after a steep run-up whereas others interpret the same period as one requiring caution due to elevated volatility and inherent risks in the small cap space.'The segment's nature tends to involve higher price swings, making it sensitive to both market sentiment and liquidity. Whether the current moment is seen as an entry point or a phase of uncertainty depends largely on individual perspectives, investment strategies, and tolerance for volatility,' he added.The CIO of Trust Mutual Fund commented on the earnings and valuations and said that the overall, small caps offer superior earnings growth compared to large caps and the valuations in terms of PE ratio is similar and hence the growth adjusted valuation of small caps is quite comfortable.Amid all the debates that were going on related to SIP in small caps, the category received a drop in inflows in February but again saw a surge in March.According to the last available data by Association of Mutual Funds in India (AMFI), small cap funds saw a surge of 10% in inflows on monthly basis receiving a total inflow of Rs 4,092 crore in March against an inflow of Rs 3,722 crore.With the category that gained investors' interest in March again, Vora of Trust Mutual Fund comments that given the correction that has already happened, we are not worried about small cap performance going forward and investors with an equity investment horizon of three years or more can consider small caps as an option.Small cap schemes invest in very small companies or their stocks. That is why investing in small cap stocks is considered extremely risky. The small cap segment can be extremely volatile in the short term, but they have the potential to offer very high returns over a long period. Small cap schemes are recommended only to aggressive investors with a high-risk appetite and long investment horizon, say, around seven to 10 years. ETMutualFunds do not recommend small cap schemes to new and inexperienced investors.One should always consider their risk appetite, investment horizon and goals before making any investment decision.: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)If you have any mutual fund queries, message on ET Mutual Funds on Facebook/Twitter. We will get it answered by our panel of experts. Do share your questions on [e-mail] alongwith your age, risk profile, and twitter handle