As valuations in mid and small-cap stocks remain elevated, investors should be cautious and temper their return expectations. They should consider increasing exposure to large-cap stocks.
Mid and small-caps are currently trading above the long-term average. These elevated levels make them more susceptible to market volatility and corrections. In November, while Nifty 50 delivered positive returns of around 2%, BSE Midcap index remained largely flat and the BSE Smallcap index recorded negative returns.
Past returns due to low base
Small and mid-caps have delivered exceptional returns over the past five years. Prashant Jain, co-founder and chief investment officer, 3P Investment Managers, in a recent newspaper interview has said the higher returns is largely a result of the low base they had fallen to post Covid. While large-cap stocks fell by 30-40%, mid and small-caps fell by 60-70%. This created an abnormally low base for mid and small-caps.
Once the economy reopened, revenues and margins normalised quickly. Moreover, domestic liquidity surged through systematic investment plans powered by a sharp re-rating from deeply depressed valuations. Going forward, returns in small and mid-caps will depend more on fundamentals and valuation than on base effects.
Exposure to large-caps
Large-caps continue to attract strong institutional flows, which typically come in quickly and in large volumes—providing these companies with greater stability, liquidity, and market resilience.
Soumya Sarkar, co-founder, Wealth Redefine, an AMFI registered mutual fund distributor, says, given stretched valuations, caution in small and mid-caps is essential. “Their recent high returns have increased risk, making them vulnerable to sharp downturns. Shift some allocation towards more stable large-caps,” he says.
Large-cap stocks have clearly taken the lead in YTD 2025, even as mid- and small-cap segments have lost some momentum. The rally within large caps is being driven by a concentrated set of high-quality companies. “In the current market environment, large-caps offer a more compelling risk-adjusted return profile,” says Nirav Karkera, head, Research, Fisdom.
Relying solely on aggregate indices can be misleading. N. ArunaGiri, CEO, TrustLine Holdings, an equity research and asset management firm, says a large number of underlying stocks in small-caps are down 40–50% from their highs. “The same story holds true for the mid-cap segment as well,” he says.
However, investors should not ignore small and mid-caps completely. “Small and mid-cap stocks can create wealth over time as companies move up the value chain,” says Swapnil Aggarwal, director, VSRK Capital.