These funds outperformed the benchmark index, which rose 3.25% on robust inflows from foreign institutional investors (FIIs) and hopes of easing monetary policy.
Favourable global liquidity conditions encouraged foreign investors to buy more than $7 billion of Indian equities so far in 2012, pushing up the index by more than 14%. "With the backing of FIIs, retail participation increased in mid- and small-caps, which pushed them higher," said Taurus Mutual Fund managing editor RK Gupta.
Mid- and small-cap shares accounted for more than a third of the assets of diversified funds at the end of January, and holdings of such stocks rose to the highest level since January 2011, Morningstar India data showed.
During the month, the BSE mid-cap index rose 8.8% while the small-cap index gained 6.14%. Exposure to the financial services sector the top sector bet for money managers, with an allocation of over 20% also helped equity diversified mutual funds as the Bombay Stock Exchange banking index rose 5.12%.
Shares of top-lender State Bank of India gained 9%, while HDFC Bank rose 5% on hopes the central bank will further reduce the cash reserve ratio for banks to help ease tight liquidity conditions.
Two diversified funds from HSBC, the HSBC Midcap Equity Fund and the HSBC Progressive Themes Fund, were India's top performing mutual funds in February, returning more than 11%.
Among sectoral funds, those focusing on technology returned more than 7% while those investing in financial services registered a rise of nearly 6%. IT stocks were among the best performers in February, pushing up the BSE IT index by 6.6%.
Fixed income funds that invest in government securities rose 0.75% in the month, as the yield on the benchmark bond fell 7 basis points.