Small-cap mutual funds delivered a sharp rebound in April, with returns surging as much as 20 per cent, sparking fresh debate among investors on whether to stay invested or take profits off the table.
The rally comes after a volatile phase in which small-cap segments had seen pressure and intermittent corrections. However, a combination of steady inflows, improving sentiment, attractive valuations, and a valuation reset from previous highs has revived momentum in the segment.
What drove the 20% rally in small caps?
Speaking on a Zee Business discussion, Hrishikesh Palve, Director at Anand Rathi Wealth, attributed the rally to a mix of structural and cyclical factors.
He highlighted four key drivers behind the recent surge:
1) Consistent investor inflows and improving sentiment
Palve noted that small-cap funds have seen sustained participation. Between January and April, there were only a few days of negative net flows, reflecting growing investor confidence. Monthly inflows also remained strong—around Rs 3,800 crore in February, Rs 6,300 crore in March, and Rs 5,800 crore in April.
He also added that over this period, broader market participation remained strong, supported by consistent SIP flows, even when volatility persisted.
2) Strong domestic institutional support
Domestic Institutional Investors (DIIs) provided significant cushion, investing about Rs 1.46 lakh crore, even as Foreign Institutional Investors (FIIs) pulled out roughly Rs 1.12 lakh crore from Indian markets.
This divergence between domestic buying and foreign selling helped stabilise mid and small-cap segments.
Systematic Investment Plans (SIPs) continue to act as a strong structural support, with monthly contributions estimated in the Rs 28,000–Rs 32,000 crore range, ensuring steady liquidity into equity markets.
This SIP discipline also helped investors accumulate units during market corrections, improving overall portfolio outcomes for long-term participants.
4) Attractive valuations and earnings recovery
Palve pointed out that small-cap valuations had corrected meaningfully earlier, with the sector trading closer to long-term averages after a significant PE compression from earlier elevated levels. This made them attractive again.
He also added that earnings growth expectations remain strong, with estimates suggesting around 40 per cent+ growth in some quarters, supporting the recovery narrative.
Why did the bounce feel so sharp?
Kshitiz Mahajan, CEO of Complete Circle Wealth, explained that small-cap rallies tend to be sharper due to liquidity dynamics.
He said small-cap stocks have relatively low liquidity compared to large caps, meaning even moderate buying pressure can push prices up quickly. Conversely, during sell-offs, declines can also be sharper.
He further highlighted that in April, small caps outperformed broader indices significantly—while Nifty delivered around 7 per cent returns, small-cap indices delivered nearly 17–20 per cent, reflecting this liquidity effect.
Mahajan added that after a correction from recent highs (nearly 25–30 per cent in small-cap indices earlier), and a valuation reset, investors—especially domestic institutions and funds—returned to small caps, triggering a faster rebound.
He also pointed out that IPO market fatigue and a shift of capital back into secondary markets contributed to mutual fund inflows into small and mid-cap categories.
He added that valuations had become attractive, with small-cap indices correcting from elevated levels (PE falling from around 33–34 to nearly 24 levels), which triggered fresh buying interest.
Stay invested or book profits?
On the key question investors are asking—whether to exit after the rally—both experts leaned strongly toward a long-term approach.
Hrishikesh Palve emphasised that small-cap investing is fundamentally a long-term strategy. He suggested that investors should ideally maintain a 7+ year horizon, noting that small caps can outperform large caps by 1.5–2 per cent annually over time, but come with higher volatility.
He also referenced the ‘mean reversion’ concept, noting that long-term small-cap returns tend to gravitate toward historical averages of around 14–15 per cent. He added that recent returns reflect a cyclical recovery phase rather than an abnormal spike.
He further explained that over very short periods, returns may deviate sharply (even turning slightly negative in recent years), but tend to normalise over longer cycles.
Kshitiz Mahajan echoed a similar view, advising against reacting to short-term moves. He recommended maintaining disciplined allocation—typically:
- 50 per cent large cap
- 30 per cent mid-cap
- 20 per cent small cap
He also advised SIP and STP-based investing rather than lump-sum timing, especially in volatile segments like small caps. He suggested staggered investing through STPs over 12–14 instalments for better risk management.
What should investors do now?
Experts broadly agree on three key points:
- Avoid panic booking of profits after short-term rallies
- Stay invested with a long-term horizon (7–10 years)
- Use staggered investing methods like SIPs or STPs
Mahajan added that even if investors missed part of the rally, small-cap opportunities remain intact as many companies in this space are potential future mid-cap or large-cap leaders.
He also emphasised that disciplined SIP investors benefited from accumulating units during earlier corrections, which is now reflecting in portfolio gains.
Key takeaways for investors
The April rally in small-cap funds has revived optimism, but experts caution against treating it as a short-term trading opportunity. Instead, they see it as part of a longer cyclical recovery supported by valuations, liquidity, strong domestic flows, and earnings growth expectations.
As Palve summed it up, small caps remain a “high-return but high-volatility” segment best suited for disciplined, long-term investors rather than short-term profit booking strategies.