However, this badge of honour may come with its own set of challenges, some experts say. They believe that as a fund grows bigger, it becomes harder for the fund manager to generate alpha (returns above the benchmark). The rationale? As a fund grows, the manager needs to buy and sell in ever-larger quantities, which makes it difficult to enter and exit smaller companies and benefit from their rapid growth.
While other categories like flexi cap have huge funds as well, experts said these have the flexibility to spread their investments across various categories of stocks, while mid cap funds must invest at least 65% of their corpus in the mid cap universe of 150 companies (100th to 250th by market cap).
According to Value Research, HDFC Mid Cap Fund has delivered a 19.03% compound annual growth rate (CAGR) over the past 10 years and 30.43% over the past five (as of 9 September). For comparison, the benchmark BSE MidCap 150 TRI delivered a 18.31% CAGR over 10 years and 28.19% over five.
HDFC Small Cap, also managed by Setalvad and the second-largest such fund after Nippon Small Cap, has delivered a 20.24% CAGR over 10 years and 31.49% over five. The benchmark BSE 250 SmallCap TRI delivered 16.38% and 29.21% over 10 and 5 years, respectively. Nippon Small Cap has ₹66,000 crore in AUM and HDFC Small Cap has ₹36,400 crore.
Mint spoke to Setalvad to understand whether size can hinder a fund’s performance and how investors should view investing in large funds.
Optically larger, relatively unchanged
Setalvad pointed out that the size of HDFC Mid Cap fund as a percentage of the mid cap universe has barely changed over the past few years, from 0.98% in 2020 to 1.02% at present. As of June, the size of the entire mid cap universe was ₹82 trillion (lakh crore) and HDFC Mid Cap Fund’s AUM was ₹85,000 crore.
He said size was just one of five main factors that affect the performance of a fund, the others being stock selection, sector allocation, style (growth, value, momentum, etc) and luck.
“HDFC Mid Cap has been the largest mid cap fund for more than a decade and we’ve had good performance, poor performance, and average performance (over this period). If fund size were a negative factor, we would’ve underperformed consistently. But that has not been the case. In fact, funds with larger AUMs in the mid cap and small cap categories have done better than others,” he added.
If size was becoming an issue, we would have shifted to larger companies by market cap, but that’s not the case, he said. The weighted average market cap of companies that HDFC Mid Cap holds is ₹49,000 crore, versus the category average of ₹61,000 crore, according to Value Research data. The average market cap of companies in HDFC Small Cap’s portfolio is ₹14,587 crore, versus the benchmark average of ₹18,888 crore. This shows size hasn’t forced it to dilute its investment strategy, Setalvad said.
“We are a large fund but don’t act like one, whereas there can be low-AUM funds that behave like large funds,” he added.
Stress test: how long to liquidate?
According to a stress test conducted by the Association of Mutual Funds in India (AMFI) in July, it would take 37 days to liquidate 50% of HDFC Mid Cap Fund’s portfolio and 19 days to liquidate 25% – the poorest metrics in the mid cap space. For HDFC Small Cap fund, it would take 54 days to liquidate 50% of the portfolio and 27 days to liquidate 25%. Both Quant Small Cap and SBI Small Cap would take longer to liquidate their portfolios, AMFI found. SBI Small Cap stopped accepting fresh lump-sum investments from September 2020.
Setalvad agreed that HDFC Mid Cap’s portfolio was less liquid than those of other mid- and small-cap funds but justified this by saying it was better to own high-quality illiquid companies than poor-quality ones with liquidity. “I could spread my portfolio across 150 stocks and improve liquidity, but would that be high-quality portfolio?” he asked. The number of stocks in the HDFC Mid Cap and HDFC Small Cap portfolios is 72 and 82 stocks, respectively as on 31st Aug 2025.
Investment philosophy
HDFC Mutual Fund looks for companies with good returns on capital, decent cash flows, and relatively lower price-to-earnings (PE) ratios compared to the benchmark, and creates a portfolio of 70-75 such stocks. Setalvad said this investing style hasn’t changed since inception.
The average PE ratio of the HDFC Mid Cap fund is 26.32 vs the category average of 35.52. HDFC Small Cap’s is 24.67 vs 32.02 for the category. A lower P/E ratio means the stock may be undervalued compared to its earnings.
Both funds also hold cash and liquid large-cap stocks, which will act as a cushion when redemption pressure is high or during a sustained downturn.
Mid- and small-cap funds have to invest 65% in their respective categories and can deploy the remaining 35% across other market segments and cash. Currently, HDFC Mid cap has 7.37% in large caps and 7.22% in cash, while HDFC Small cap has 3.74% in large caps and 8.93% in cash, as of July AMFI disclosures.
“Historically, cumulative redemptions during downturns have not been significant. Despite that, we have many layers of protection,” Setalvad said.
Free float concerns
An analyst at a large wealth management company told Mint that HDFC Mutual Fund’s mid cap and small cap funds have a few stocks in which it holds a significant chunk of the free float (shares outstanding that can be traded freely), which could make it difficult to exit these positions.
In response, Setalvad argued that since the funds included high-quality companies, they could do block deals even during bear markets as high-quality stocks would trade at cheaper valuations.
“We do own a significant portion of the free float in some stocks. But is it better to own a large proportion of free float in a high-quality company or a low proportion of free float in an average company?” he said.
“As markets fall, liquidity and block deals will emerge as people want to buy companies when they are cheap. If a company is available at a PE of 50, people won’t want to transact in blocks, but if it’s available at a PE of 15, block opportunities will show up,” he added.
What other experts say
Nirav Karkera, head of research at Fisdom, said, “Size, in isolation, is not the primary constraint for mid cap fund managers in delivering alpha. The nature of the constraint is far more nuanced and heavily context-dependent. The mid cap space is fragmented in terms of business segments, valuations, and earnings growth trajectories, and a bottom-up approach is critical to generating alpha.”
Karkera said that although HDFC Mid Cap Fund was growing, the aggregate free float market cap of mid caps was also expanding. “As long as position sizes within the fund are relatively modest, sufficient to meaningfully mitigate liquidity and impact cost challenges, size is not the foremost constraint,” he added.
Saurabh Mittal, a registered investment advisor and founder of Circle Wealth Advisors Pvt. Ltd., said, “Assets comprising 1% of the total midcap universe is a more accurate indicator than the illusion created by the absolute AUM number. With 73 stocks, [HDFC Mid Cap Fund’s] overlap with the Nifty Midcap 150 index is only 29%, indicating that the portfolio is not hugging the benchmark.”
However, if you compare the numbers on a five-year daily rolling basis from September 2015 to date, there are approximately 1,300 observations. The average of these data points is 18.63 for HDFC Midcap and 19.85 for Nifty Midcap TRI. This suggests it may be difficult for an active manager to beat the index consistently.”
Juzer Gabajiwala, director at Ventura Securities, said the smallest mid cap company five years ago had a market cap of ₹26,000 crore. Now, it’s ₹90,000 crore. “Liquidity thus may not be an issue with the spurt in market cap of these companies. Quality is a very important factor for fund investing, and with a larger AUM, liquidity won’t be a constraint.”
He added, “Since mid cap funds can invest up to 35% of their corpus outside the mid cap universe, a larger fund has more flexibility to invest in large- and small-cap companies as well. HDFC has invested in only 38 mid cap companies, or just 25% of the total number of companies in its portfolio.”