The last three months have been difficult for equity investors. Benchmark indices have remained under pressure amid foreign investor selling, concerns over global growth, rising crude oil prices, geopolitical tensions and a weakening rupee. The BSE Sensex has fallen 7.21% over the past three months, while the Nifty 50 has declined 5.64%.
Yet, one mutual fund category has managed to stand out in this challenging environment, and by a wide margin.
Small cap mutual funds have delivered an average return of approximately 12% over the last three months, making them one of the best-performing diversified equity fund categories during the period. Their outperformance relative to broader market benchmarks and peer categories has been substantial.
Small cap funds leave peers behind
Data from Value Research shows that small cap funds generated an average return of approximately 12% over the last three months ending April 2025.
The gap with other equity categories is striking. Large cap funds delivered negative returns over the same period. Large and mid cap funds managed a modest gain of 1.04%, while flexi cap funds returned 1.85%. Mid cap funds performed relatively better at 6.22%, but that was still well below what the small cap category delivered.
The table below puts the numbers in context across multiple time horizons:
| Fund Category | 3-Month Return | 1-Year Return | 3-Year CAGR | 5-Year CAGR |
| Small Cap | 11.82% | 2.36% | 18.26% | 16.66% |
| Mid Cap | 6.22% | 3.88% | 19.32% | 16.57% |
| Large & Mid Cap | 1.04% | (-)0.38% | 14.32% | 13.39% |
| Flexi Cap | 1.85% | (-)0.58% | 13.12% | 11.51% |
| Large Cap | (-)1.71% | (-)1.60% | 11.56% | 10.35% |
(Source: Value Research)
Why did small cap stocks rally while large caps struggled?
The answer lies in the performance of underlying small cap stocks. The Nifty Smallcap 250 TRI gained 10.58% during the last three months, sharply outperforming the Nifty 50 and the Sensex. Since small cap mutual funds invest predominantly in this segment, they naturally benefited from the rally — and active fund managers, on average, added further alpha over the index.
Three factors drove this performance:
First, domestic demand held up. Many small cap companies with a domestic revenue focus continued to report healthy growth. These businesses benefited from ongoing infrastructure spending, capital expenditure activity, and resilient consumer demand — areas less exposed to the global headwinds that weighed on export-oriented large cap sectors.
Second, valuations had corrected. Small cap stocks had experienced a sharper pullback before the recent rally. As prices fell, investors saw an opportunity to accumulate quality businesses at more attractive entry points. The buying that followed helped accelerate the rebound.
Third, the rally was concentrated in sectors where small cap companies have an outsized presence — infrastructure, defence, media, and other cyclical segments. This sectoral tailwind amplified returns across the category.
One strong quarter does not tell the full story
The recent three-month performance looks impressive. But investors should be cautious about drawing conclusions from a single short-term window.
Zoom out to one year, and the picture becomes more nuanced. Small cap funds have generated an average return of 2.36% over the last twelve months.
While that is better than large cap funds, which posted negative returns over the same period, it trails the 3.88% delivered by mid cap funds.
This suggests that small cap funds have staged a strong comeback in the most recent quarter, but their one-year track record remains modest.
What do longer-term returns show?
Looking beyond one year, the category’s track record strengthens considerably.
Over three years, mid cap funds have slightly outperformed small cap funds — delivering an annualised return of 19.32% compared with 18.26% from small cap funds. However, the picture shifts over a five-year horizon. Small cap funds delivered an annualised return of 16.66%, marginally ahead of the 16.57% CAGR generated by mid cap funds.
The data suggests that despite phases of sharp volatility, small cap funds have rewarded investors who remained invested over full market cycles.
For this comparison, diversified equity categories have been considered: large cap, large and mid cap, flexi cap, multicap, ELSS, mid cap, and small cap funds. International funds and sectoral or thematic funds have been excluded.
Top-performing small cap funds over the last three months
Among active small cap funds, a handful of schemes have delivered significantly stronger returns than the category average over the last three months. All figures below are for direct plans and are sourced from Value Research.
| Fund Name | 3-Month Return (Direct Plan) |
| Bank of India Small Cap Fund | 23.74% |
| TRUSTMF Small Cap Fund | 21.28% |
| JM Small Cap Fund | 19.48% |
| Motilal Oswal Small Cap Fund | 18.25% |
| Quant Small Cap Fund | 17.54% |
(Source: Value Research. Data as of June 5. Past performance is not indicative of future results.)
Investors should not ignore the risks
The recent rally may tempt investors to chase returns. Small cap funds, however, remain among the riskiest equity mutual fund categories — and earlier in 2025 served as a sharp reminder of this.
After delivering exceptional gains in 2023 and 2024, small cap funds witnessed a significant correction in the first part of 2025. The category posted negative returns as concerns around elevated valuations, election-related uncertainty, and global economic headwinds weighed on sentiment.
The Nifty Smallcap 250 TRI also declined during this period, and many actively managed small cap funds experienced double-digit losses at various points.
Small cap stocks are structurally more volatile than large cap stocks. They can rise sharply during favourable market conditions but can also suffer deeper and more prolonged corrections when sentiment turns. Liquidity constraints in this segment can amplify both moves.
Financial planners generally advise investors to assess their risk appetite, investment horizon, and overall asset allocation before increasing exposure to the category.
Summing up…
Small cap funds have emerged as the standout category over the last three months, delivering approximately 12% at a time when benchmark indices fell and most equity fund categories struggled to generate meaningful gains.
But the recent rally should not be viewed in isolation. The category also experienced sharp corrections earlier in 2025, and its one-year return remains modest despite the recent pickup. Long-term data — across three and five years — presents a more compelling case.
Small cap funds are best suited for investors who can tolerate higher volatility, maintain a long investment horizon, and stay invested through full market cycles. For such investors, the category can play an important role in wealth creation. Chasing short-term performance alone, however, is rarely the right strategy in this segment.
Disclaimer: Past performance is not indicative of future returns. Mutual fund investments are subject to market risks. Small cap funds can be highly volatile and may witness sharp corrections during adverse market conditions. Investors should assess their risk appetite, financial goals and investment horizon before investing. Returns mentioned are category averages and scheme level performance based on data sourced from Value Research.
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