Small-cap funds are no longer a small corner of India’s mutual fund market. A steady stream of retail money has pushed SIP-linked assets in the category to Rs 1.83 lakh crore in March 2026 from Rs 35,489 crore in March 2021, while total small-cap fund AUM has reached Rs 4.41 lakh crore by July 2026.
The growth is striking when compared with the broader mutual fund industry. Small-cap fund AUM has risen nearly 4.6 times in five years from around Rs 96,000 crore in July 2021, while the overall mutual fund industry’s AUM has grown about 2.45 times, from a little over Rs 35 lakh crore to around Rs 86 lakh crore.
The question now is not simply whether investors are putting more money into small caps. The bigger question is what this steady flow of money means for valuations, liquidity and risk in a segment known for sharper ups and downs.
Small-cap mutual fund AUM has grown 4.6X in 5 years
Small-cap funds have become a much bigger part of the equity mutual fund universe. They are now the fourth-largest equity fund category by AUM, behind flexi-cap, sectoral and thematic funds, and mid-cap funds, with each of the three larger categories having more than Rs 5 lakh crore in assets.
The SIP route has played an important role in this expansion. Small-cap funds accounted for 12.1% of the mutual fund industry’s total SIP AUM in March 2026, while SIP-linked assets made up nearly 55% of the category’s total AUM.
For fund managers, however, a growing SIP pool does not automatically change how portfolios are built. Chirag Setalvad, Head – Equities, HDFC AMC Ltd, says the approach remains focused on individual businesses rather than simply finding stocks where incoming money can be deployed.
“The rise of SIPs doesn’t really change the way in which we develop portfolio. We follow a stock specific approach and construct our portfolio on a bottom-up basis with a focus on well-run companies at sensible prices.”
At the same time, regular SIP flows can make managing money somewhat easier. “SIPs do help in managing overall liquidity as they provide steady inflows even in markets which are skittish and that are seeing lump sum outflows.”
Why investors are pouring more money into small-cap funds
The flow of money into the category has grown sharply over the past few years. Small-cap mutual fund inflows increased from Rs 10,145 crore in FY22 to Rs 51,872 crore in FY26, while their share of total equity mutual fund inflows doubled from 6% to 14%, according to Ambit Asset Management.
Domestic investors have become an increasingly important source of liquidity for small caps. Ambit estimates that annual inflows into small-cap mutual funds were equivalent to about 1.4% of small-cap market capitalisation, compared with just 0.3% for large caps.
Strong market performance has also helped. The Nifty Smallcap 250 delivered 48.1% in calendar year 2023 and 26.4% in 2024, before falling 6% in 2025. Historically, the index has delivered higher returns than large caps, but with significantly higher volatility.
There is also a fundamental story behind the flows. Small caps have greater exposure to themes such as manufacturing, infrastructure, power, capital expenditure and exports, while the earnings outlook has improved in recent quarters.
Ambit estimates that the Nifty Smallcap 250 recorded a 27% year-on-year increase in profit after tax as of June 2026, with revenue and EBITDA growth also improving over the previous two quarters.
Small-cap fund inflows show how powerful the money flow has become
The latest monthly numbers show that the flow of money into the category is still strong. Small-cap funds received Rs 7,767 crore in net inflows in July 2026, compared with Rs 1,778 crore in July 2021, based on the data provided for this comparison.
Top equity fund categories by AUM — July 31, 2026
| Equity fund category | No. of schemes | July 2026 net inflow (₹ crore) | AUM (₹ lakh crore) |
| Flexi Cap Fund | 45 | 4,709.08 | 6 |
| Sectoral/Thematic Funds | 251 | 1,328.27 | 5.62 |
| Mid Cap Fund | 33 | 6,192.31 | 5.23 |
| Small Cap Fund | 36 | 7,767.50 | 4.41 |
| Large Cap Fund | 35 | -1,321.69 | 4.16 |
(Source: AMFI)
That means monthly inflows were around 4.4 times higher than five years ago. While this is not the same as SIP-only inflows, it shows how dramatically the pool of money going into the category has expanded.
This matters because mutual funds ultimately have to deploy the money they receive. If the supply of attractive small-cap stocks does not grow as quickly as the assets coming into the category, there can be pressure on stock prices and valuations.
But Setalvad does not see regular SIP flows as the same risk as sudden bursts of lump-sum money.
“Valuations get over extended for a variety of reasons and excess liquidity is certainly one of them. This normally happens when there is a surge in inflows which is typically more lump sum in nature.”
Can rising SIP flows push small-cap valuations higher?
The concern is not that every rupee coming through an SIP automatically makes small caps expensive. The bigger issue is whether persistent demand can keep valuations elevated when earnings growth is not strong enough to support them.
Setalvad says liquidity-driven valuation expansion tends to be short-lived unless it is supported by business performance. “Liquidity driven valuation expansions tend to play out quickly but the impact tends not to last unless followed up by strong underlying fundamental performance.”
At the same time, he does not dismiss the impact of a large SIP pool. “However, steady and large SIPs can certainly support a stock or market and does have a lingering impact.”
For investors, this distinction is important. A company with strong earnings growth can justify a higher valuation, but a stock can also rise simply because it is part of a popular theme and is attracting more money.
Nitin Jain, Vice President – Equity at UTI AMC, says this is something fund managers have to watch closely, particularly when a theme becomes crowded.
“In some cases, valuations are driven by flows, particularly where the themes are hot at the moment and everyone is chasing them.”
His approach is to separate short-term excitement from longer-term business opportunities. “We try to differentiate between themes that are short-term (next few quarters) versus multi-year themes.”
That is why the recent correction in small caps is an important part of the story.
What the 2025 small-cap correction taught investors
The small-cap correction that began in early 2025 was primarily a valuation reset, according to Ambit. The brokerage notes that the earlier period of strong performance had been followed by slower earnings growth, profit-taking and greater investor caution.
Jain believes investors made the mistake of assuming that the unusually strong post-Covid growth environment would continue indefinitely.
“Post COVID period offered very favourable environment – commodity prices and interest rates were low, export environment was healthy, companies were coming off a very weak base of growth and margins and most importantly, the valuations were favourable.”
The problem was that investors began extrapolating those exceptional years into the future. “High earnings growth expectations (after a couple of extraordinary years), coupled with high valuations meant little margin for errors in the system.”
That lesson remains relevant even as the small-cap market has recovered. “The most important lesson was to pay respect to business fundamentals and valuations and not get influenced by the momentum in the markets.”
The valuation picture, however, is not as stretched as it was at the peak of the previous rally. Ambit’s July 2026 analysis found that 47% of small-cap stocks were trading below their 10-year average valuations, compared with 31% of mid-caps and 27% of large caps.
This suggests that investors should not treat the entire small-cap universe as expensive. There are still companies trading below their historical valuation averages, although that does not mean every stock offers value.
Small-cap fund liquidity is improving, but risks remain
One of the biggest changes brought by the surge in domestic money is improved liquidity. Ambit says the 30-day average traded value of Nifty Smallcap 250 constituents recovered from around $8.3 million in February 2025 to $12.2 million by June 2026, moving above pre-correction levels.
The report says resilient domestic inflows have also helped offset periods of foreign selling. Domestic investors now play a much larger role in determining liquidity conditions in the small-cap segment.
For fund managers, this is a positive development. But liquidity remains a risk that cannot simply be assumed away because SIP money is coming in every month.
Jain says fund managers remain cautious about what could happen during a sharp redemption phase. “Liquidity is a critical key risk management factor, particularly in the event of any sharp redemption pressures.”
The bigger question is what happens when the market does not recover quickly. A short correction may not change investor behaviour much, but several quarters of weak or range-bound returns could test the discipline of newer mutual fund investors.
Jain says the recent period has not provided enough evidence to know how investors would behave in such a situation. “This period did not witness any material redemption pressure. However, this is a very short period to take any takeaways from and hence one cannot be sure about the investor behaviour in the future if the stocks remain range-bound for a long period of time.”
Can SIP inflows protect small-cap funds during a market fall?
A large SIP base can provide a cushion when markets are unsettled because new money continues to come in even when some investors are withdrawing lump-sum investments.
But that cushion has limits. Setalvad says, “A steady SIP base certainly helps cushion the impact of outflows to some extent so long as the outflows are not very large or concentrated.”
If investors begin redeeming heavily at the same time, regular inflows may not be enough. “If there are meaningful outflows in a short period of time, it would tend to overshadow the impact of any SIP inflow.”
This is the liquidity paradox at the heart of the small-cap story. The same domestic money that has made the market deeper can also become a source of pressure if the direction of the flow changes sharply.
SIP investors also have to remember that a SIP is a method of investing, not a protection against losses. It can bring discipline and reduce dependence on timing the market, but it does not make a volatile asset class less volatile.
Small-cap fund risk remains higher than large caps
Ambit’s historical analysis shows just how wide the difference can be. The Nifty Smallcap 250 has had a return range of -69% to 114%, compared with -52% to 76% for the Nifty 50, while median volatility was 16% for small caps against 12% for the Nifty 50.
That does not mean investors should avoid small-cap funds. It means the size of the SIP pool should not be mistaken for a reduction in the underlying risk of the asset class.
Setalvad says valuation discipline remains important even if it means missing out on some short-term gains. “Excessive valuations can certainly compromise short or even medium-term returns depending on the extent of excess that is prevalent.”
His approach is to avoid pockets of excess rather than chase momentum. “In my opinion, if there are pockets of excess, it is best to avoid them even if it means near term underperformance.”
What should small-cap SIP investors do now?
The current backdrop is not necessarily a reason to become bearish on small caps. Ambit says the balance between risk and reward has improved, helped by stronger earnings, improving liquidity, healthier corporate balance sheets and a more reasonable valuation backdrop.
But the fivefold rise in SIP-linked assets should also not become a reason to increase allocations simply because other investors are doing so. Investors need to look at their overall portfolio allocation, investment horizon and ability to tolerate sharp falls.
The biggest risk is not necessarily that small-cap SIPs have become too large. It is that investors may start believing that a regular flow of money can make small caps behave like a stable asset class.
The real test for this ₹4.41 lakh crore category may come during a prolonged correction, when returns remain weak for long enough to test both investor patience and fund-level liquidity.
For now, the small-cap story has several positives: earnings are improving, liquidity has recovered and valuations have reset from their earlier extremes. But as the category becomes larger and attracts more retail money, the old rules still apply—fundamentals, valuations and risk discipline matter more than the size of the SIP flow.
Disclaimer: This article is for informational purposes only and should not be construed as investment advice. Mutual fund investments are subject to market risks, and small-cap funds can be more volatile than other equity fund categories. Investors should consider their financial goals, risk appetite and investment horizon and consult a qualified financial adviser before making investment decisions. Past performance does not guarantee future returns. The views expressed by the experts quoted in this article are their own and do not necessarily represent the views of their respective organisations.
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