Over the last five years, since the COVID-19 pandemic, small caps have been the favoured segment of the market.
According to AMFI data, inflows and folios into small-cap funds have grown 3x since December 2020.
Investors have been taking the risk and drawn to smallcaps for their wealth creation potential.
The Nifty Smallcap 250 Index has clocked an absolute return of 145% in 5 years – that’s a compounded average growth rate (CAGR) of 19.6% – and the actively managed small cap funds, a 20.4% CAGR.
However, what should also be borne in mind is that smallcaps aren’t for the faint-hearted. They can go from thrilling highs to dangerous lows.
The 2025 Correction: A Reality Check
Last year, i.e. 2025, the Nifty Smallcap 250 Index delivered -6.0% returns. Since the peak (on 23 September 2024, on closing), the Nifty Smallcap 250 Index is down 21.6% (as of 23 January 2026).
Now, that’s a big markdown.
PE of the Nifty Smallcap250 Index
Moreover, the valuations of the Nifty Smallcap 250 Index seem better placed now. The trailing price-to-index ratio of this index is currently (as of 23 January 2026) at 27x, a notch below the 5-year median of 29, and much below the peak of 35 seen in 2024. The froth in smallcaps has somewhat settled, although not completely.
And that’s precisely why small cap funds may be considered for growth potential – but you need to tread very carefully.
From Small-Cap to Mid-Cap: The Evolution of India’s Growth Stars
Several smallcap companies today are participating in India’s growth story, and quite a few have metamorphosed from smallcaps to midcaps in the last five years – for example, Mazagon Dock Shipbuilders, KEI Industries, Apar Industries, Endurance Technologies, MCX, etc.
However, when approaching small cap funds, you need to pay attention to the portfolio characteristics.
With that said, let’s dig into what, in my view, are some of the best managed small cap mutual funds in India today.
The Top 3 Contenders
Here are the top 3 small cap funds, chosen considering respectable portfolio characteristics, longer period returns and risk ratios.
Performance of the Top 3 Small Cap Fund
| Returns – CAGR | Risk Ratios | |||||
| 3 Yrs (%) | 5 Yrs (%) | 7 Yrs (%) | SI (%) | Std Dev (%) | Sharpe Ratio | |
| Nippon India Small Cap Fund | 19.7 | 25.8 | 22.9 | 23.5 | 16.6 | 0.93 |
| HDFC Small Cap Fund | 19.1 | 23.5 | 18.7 | 18.7 | 15.5 | 0.93 |
| Invesco India Small Cap Fund | 23.0 | 24.7 | 23.1 | 22.4 | 16.4 | 1.13 |
| Category Average | 18.3 | 21.7 | 20.4 | – | 17.3 | 0.84 |
| BSE 250 SmallCap TRI | 17.38 | 19.52 | 17.13 | – | 18.98 | 0.75 |
The Risk Measures have been calculated using calendar month returns for the last three years. Returns data as of 23 January 2026. The Risk Measures have been calculated using calendar month returns for the last three years and are as of 31 December 2025.
Standard Deviation is a measure of the total volatility of the fund. The Sharpe Ratio is a measure of risk-adjusted return that shows how much excess return an investment generates for each unit of risk taken.
The Portfolio Characteristics of the Top 3 Small Cap Funds
| No. of Stocks | Top 10 Stock (%) | Top 3 Sectors (%) | PB Ratio | PE Ratio | |
| Nippon India Small Cap Fund | 240 | 14.9 | 51.7 | 3.6 | 28.8 |
| HDFC Small Cap Fund | 84 | 29.5 | 54.5 | 3.0 | 23.0 |
| Invesco India Small Cap Fund | 64 | 36.1 | 58.3 | 4.8 | 39.8 |
The average of the price-to-book value ratios and price-to-equity ratios of all underlying stock holdings in proportion to their portfolio weights is considered.
Portfolio data as of 31 December 2025
#1: Nippon India small cap fund
Nippon India Small Cap Fund was launched in September 2010 as the Reliance Small Cap Fund. After Nippon Life Insurance completed the takeover of Reliance Mutual Funds in September 2019, it was rechristened as Nippon India Small Cap.
Nippon India Small Cap Fund is today the largest scheme in the small cap fund category, managing assets of over Rs 68,287 crore, as per its December 2025 portfolio.
Given its AUM, the fund currently has put an investment limit of Rs 50,000 per day per Permanent Account Number (PAN) for new Systematic Investment Plan (SIP) and Systematic Transfer Plan (STP) registrations.
Moreover, there is a monthly overall limit of Rs 11.50 lakh per PAN across all frequencies that has been implemented.
Lump sum investment has been suspended since July 2023.
Currently, the fund is holding 96% of its assets in equities. Within equities, it has 71% exposure to smallcaps, 14% to midcaps and about 15% to largecaps.
When identifying stocks for its portfolio, it looks for reasonable size, quality management, and rational valuations to identify high-growth companies.
The fund holds a very diverse portfolio of over 200 stocks across sectors.
Currently, there are 240 stocks in its portfolio, of which the top 10 comprise just 14.9% of the portfolio across sectors.
Top Holdings of Nippon India Small Cap Fund
The over-diversification of the portfolio is a double-edged sword: it could lower the risk if certain underlying securities do not perform, but could also dilute the returns when some portion of the fund is underperforming.
Other than smallcaps and midcaps, the fund is also holding certain heavyweights, such as Reliance Industries, HDFC Bank, SBI, etc., in its top holdings.
Having said that, considering the PE and PB ratios, the fund seems value-conscious when approaching smallcaps and other stocks. This is good, particularly because the froth in smallcaps hasn’t completely settled down yet.
The fund follows a buy-and-hold approach, as indicated by its low portfolio turnover ratio of around 14% in the last one year.
Besides, at present, the fund is holding 4% of its total assets in cash & cash equivalents.
The strategy followed by the fund has yielded appealing returns for investors over the longer periods. Over 5 years and 7 years, the fund has clocked a CAGR of 19.6% and 25.8%, respectively (as of 23 January 2026).
In addition, it has fared well on a risk-adjusted basis. The risk (as denoted by the standard deviation of 16.5%) is lower than the category average, and the Sharpe ratio (at 0.93) is well above the category peers. This makes the fund a relatively low-risk and above-average performer in its category.
#2: HDFC Small Cap Fund
HDFC Small Cap Fund was launched in April 2008 amid the global financial crisis as the Morgan Stanley ACE Fund in April 2008. Following the acquisition of Morgan Stanley Mutual Fund in June 2014, it was repositioned as the HDFC Small and Mid Cap Fund. Thereafter, with effect from 9 November 2016, it was repositioned and rechristened as HDFC Small Cap Fund.
Over the years, the fund has established a solid performance track record, and its AUM has grown to Rs over 37,753 as per the December 2025 portfolio, the second highest in its category.
The fund has witnessed a substantial improvement in its performance particular since the latter half of 2020.
Currently, the fund is holding 91% of its assets in equities and 9% in cash & cash equivalents.
Within equities, currently it has 83% exposure to smallcaps, 10% to midcaps and around 7% to largecaps.
It aims to predominantly build a portfolio of small-cap companies that have reasonable growth prospects, sound financial strength, sustainable business models, and are available at reasonable valuations. A bottom-up approach to identify high-quality growth-oriented stocks for the long term.
The fund holds a diversified portfolio of 75-100 stocks. Currently, there are 84 stocks in its portfolio, of which the top 10 comprise 29.5% of the portfolio across sectors.
Top Holdings of HDFC Small Cap Fund
HDFC Small Cap is also holding certain PSU banks, which have turned out to be multibaggers.
The value buying approach, as reflected by the low PE and PB ratios of the fund, has proved rewarding.
The fund follows a buy-and-hold approach with a long-term view. The turnover ratio has typically been below 10%, indicating a low level of portfolio churning.
Also, avoiding over-diversification has worked in favour of the fund. With the approach followed, over 5 years and 7 years, the fund has clocked a CAGR of 19.1% and 23.5%, respectively (as of 23 January 2026).
The fund has exposed its investors to lower risk (standard deviation of 15.5%) than the category average, but has been an above-average performer on a risk-adjusted basis (Sharpe ratio 0.93)
#3: Invesco India Small Cap Fund
Invesco India Small Cap Fund was launched in October 2018, when the smallcaps were witnessing a long grind bear cycle.
But this proved to be an opportune time for the fund, positively impacting its performance over the years. The AUM of the fund has grown since its launch, and today it is over Rs 9,224 crore as per the December 2025 portfolio.
The fund is currently holding 98% of its total assets in equities and the remaining 2% in cash & cash equivalents.
Smallcaps are 65% of the portfolio, midcaps 26%, and around 9% is held in largecaps.
The stock selection is guided by Invesco’s internal proprietary stock categorisation framework, which includes parameters such as revenue growth, EBIDTA and PAT margin, ROE, operating leverage, profit leverage, net worth of the company, etc. Overall, it follows a bottom-up approach and holds a diversified portfolio.
Invesco Small Cap Fund usually holds around 65-80 stocks in its portfolio. Of late, it has trimmed its portfolio and is currently holding 64 stocks, of which the top 10 comprise of 36.1% of the portfolio across sectors.
Top Holdings of Invesco India Small Cap Fund
The fund’s portfolio has a higher PE and PB, but its active growth-oriented approach has augured well. It does not believe in holding too many stocks in the portfolio, which can dilute the returns.
The portfolio turnover ratio of the fund is around 52% as per the latest portfolio. It has helped the fund to maximise gains and minimise risks, keeping in mind the cost associated with it.
The approach followed by the fund, over 5 years and 7 years, has helped clock an attractive CAGR of 23.0% and 24.7%, respectively (as of 23 January 2026).
The fund has exposed its investors to below-average risk (standard deviation of 16.4%) but has fared impressively on a risk-adjusted basis (Sharpe ratio of 1.13).
Final Word
Given the market volatility, when approaching small cap mutual funds, it would be wise to take the SIP (Systematic Investment Plan) route as opposed to investing a lump sum, whereby you would be able to mitigate the risk (with rupee-cost averaging) while you endeavour to compound wealth.
Consider your personal risk appetite, broader investment objective, the financial goal/s you are addressing and the time in hand to achieve those envisioned goal/s when investing in mutual funds.
Invest sensibly.
Happy investing!
Note: We have relied on data from www.valueresearchonline.com, www.financialexpress.com, and the factsheets published by the respective fund houses throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.
Disclaimer:
Disclaimer: The above content is for informational purposes only. Mutual Fund investments are subject to market risks. Please consult your financial advisor before investing.
Rounaq Neroy has over 20 years of experience in the financial markets and investments. He is a close observer of the Indian economy and writes deeply on the capital markets, mutual funds, stocks, precious metals, asset allocation, wealth management, and investment strategy. His editorials provide interesting, actionable investment ideas to guide readers in the journey of wealth creation and make wise decisions. Rounaq was the Head of Content at PersonalFN (Quantum Information Services Pvt. Ltd.), which also owns Equitymaster.com – India’s oldest and trusted equity research house.