Investors continue to prefer small-and-mid-cap schemes over large caps despite concerns over higher valuations. In the first six months of 2025, these schemes recorded a combined inflow of Rs 46,645 crore – more than three times than that of large caps’ Rs 14,025 crore. Out of this, small-cap schemes saw inflows of Rs 24,774 while mid-cap schemes garnered Rs 21,871 crore.
This trend is quite similar to what was seen in the last year as well, when inflows into small caps and mid caps were higher by 76% than large caps at Rs 34,223 crore and Rs 34,303 crore, respectively. Large caps attracted only Rs 19,415 crore.
Flat short-term returns
What is interesting is that the returns from small and mid-cap indices in the past year’s returns have been flat. While the BSE Large Cap’s one-year returns is 0.88%, the mid-and small-cap indices have returned -0.22% and -0.17%. What seems to be attracting investors is the significant outperformance over a three-year period, when the BSE large-cap returned 48.93% while the mid-cap index returned 97.57% and small-cap index returned 106.12%.
In fact, investors seem completely unfazed by the higher valuations as well. According to Bloomberg data, the price-to-earnings multiple of the BSE Large Cap index stands at 24.34 times while that of the BSE Small Cap and BSE Mid Cap indices is 34.11 times and 36.70 times , respectively.
Eternal is the most expensive in large caps at 881.91 times PE and FSN E-Commerce in midcaps at 956.30 times. Among small-cap stocks, some of the valuations are mind boggling. For example, Solara Active Pharma is currently trading at 4,827.14 times, Uniphos Enterprises at 3,950 times, and Devyani International at 2,198.75 times.
Expert outlook
Experts believe that valuations are high in these segments, but were quick to add that good stock-selection in these segments can yield much-higher returns as well. According to Varun Goel, senior fund manager at Mirae Asset Investment Managers, Nifty 50 returns’ 30-year average is around 11-12%, and small cap indices have delivered 16-17% IRR since inception around 20 years ago and active funds have done even better, that is an attraction.
He noted that in the last five years, the returns in the small-caps space have been superlative closer to mid-30%. “From a compounding perspective, small-cap funds make a lot of sense for anybody investing for long-term objectives. In addition, there are a lot of sectors like EMS which are not part of large cap indices.”
On valuations, he said if one looks at FY27 estimated earnings, both Nifty 50 and smallcap indices are trading at same multiples at 20 times earnings, the difference being the earnings growth in the small cap space is expected to be over 20% while Nifty 50 at 12%.
However, Arun Kumar, VP and head of research at FundsIndia believes that the return differential of mid to small, large might not be very drastic like what we saw in the last five years. He, however, cautioned that the broad expectation should be that if there is any negative news, the impact on mid and small caps will be much more.
Goel’s advice is to find stocks that can deliver 20% earnings growth in the next five years from a bottom up perspective and avoid spaces which have generated froth in the past five years. “Smallcaps, by nature, are very volatile and every four-five years, a 20-25% correction in the space should be expected,” he said.
An Elara Capital report noted that fund flows into midcap funds have been concentrated, that is, 42% of incremental inflows over the past year have gone into the Motilal Oswal Midcap Fund.
It also said small cap schemes are already holding large cap allocations near their record high of 7.2%. “Despite these increases, most schemes are still underweight large caps relative to their historical averages—suggesting further scope for reallocation into large caps in the near term,” it said.