Small & mid-cap funds: Which investment strategies can help you maximise returns during market selloff

Recently, there has been a lot of attention paid to mid- and small-cap funds. Veteran fund manager S. Naren’s remarks have sparked a significant discussion on SIPs, particularly with regards to short-term investments in small and midcap funds. Many average investors see these funds as a great way to balance risk and return on their equity exposure.

During the IFA Galaxy 2025 event, S. Naren cautioned about the risks associated with small and midcap SIPs. He also pointed out the challenges fund managers face in balancing investment rationale with sales team pressure and business dynamics.

Naren emphasized the high valuations in these sectors, with median price-to-earnings ratios for mid- and smallcap stocks standing at 43. Market capitalization is disproportionately high compared to profit-after-tax contributions, and momentum in these areas has recently decreased. With investors entering at elevated valuations, medium-term returns may be lower than expected.

He recommended to exit this space unless investors are willing to commit to their Systematic Investment Plans (SIPs) for a minimum of 20 years. In addition, diversification into megacap, largecap, flexicap, and hybrid funds was suggested.

Why midcap, small cap funds

It is widely believed that fund houses often strive to maximize their focus on meeting the high demand for small and midcap investments, even during challenging market conditions. Recent data on small and mid cap funds has shown negative returns over the past three and six months, leading to a significant reduction in investor wealth.

How should one keep investing in midcap, small cap funds

While SIPs are often touted as a wise investment strategy for navigating market volatility and averaging costs in equities, it is important to note that the experience may not always be consistently positive for investors. SIPs can be particularly advantageous in a fluctuating market, and they can also prove beneficial in Small Cap Funds and Mid Cap Funds when valuations are at or near their lowest points.

Akhil Chaturvedi, Chief Business Officer and Executive Director at Motilal Oswal AMC, emphasized the importance of strategic planning when investing in mutual funds. He suggested that investors should allocate their funds in large, mid, or small cap options based on their individual risk tolerance and investment time horizon.

“SIPs works best for very long term benefiting from rupee cost averaging. Indian investors have come of age and slowly adding equities to their over all allocation for better compounding and wealth creation. I always recommend flexi fund for investors who find it difficult to decide market cap basis allocation,” Chaturvedi said. 

Samir Shah of Axis Securities said: “Distributors often face the challenge of advising clients on whether to increase allocations to these sectors that appear to have good potential, even when it may not be wise to allocate additional funds to mid-cap and small-cap stocks.”

How long should you stay invested

SIPs are frequently touted as a wise method of investing in equities, allowing for the averaging of costs amid market fluctuations. However, it is important to note that the investor’s journey with SIPs may not always be smooth and gratifying.

While SIPs are most effective in a volatile market, they can be particularly beneficial for investors in Small Cap Funds and Mid Cap Funds when valuations are near their lowest point. It is crucial to understand that investing in Small Cap Funds and Mid Cap Funds through SIPs with an investment horizon of 3-5 years may not necessarily result in a positive and rewarding experience.

For those considering investment in Small Cap Funds and Mid Cap Funds via SIPs, a longer horizon of 8-10 years or more is advisable in order to achieve meaningful returns. This extended timeframe allows for the potential benefits of compounding and helps to mitigate risk through the rupee-cost-averaging feature inherent in SIPs.

To maximise the benefits of Systematic Investment Plans (SIPs), it is crucial to maintain a long-term investment horizon, select funds that align with your risk tolerance and financial goals, and practice discipline. Regrettably, many investors fail to do so and engage in panic selling.

Historically, for long-term investors, remaining invested and refraining from panic selling during periods of volatility has shown to be more advantageous.

In a recent post, Radhika Gupta, MD & CEO of Edelweiss Mutual Fund, wrote: “Since we are all trying to decipher whether to stop, start, time or play the dip, on something as simple as a SIP, some interesting data that may help… I had shared our midcap fund has a minimum 10 year SIP return of 8 pc. Here is similar data for indices (not index funds because you have to reduce fees / tracking error). Again no negative returns in midcap (although the active fund had alpha), and virtually none in small cap.”

According to Gupta, SIPs are intended as an uncomplicated, enduring investment strategy. She noted that a well-managed combination of mid-cap and small-cap investments can be advantageous. Gupta highlighted that market fluctuations might yield unsatisfactory short-term returns, underscoring the significance of maintaining SIPs for a minimum of 10 years.

Mahek Tomer, Founder & CEO, India’s Future Investors (IFI), says SIP remains a prudent strategy for those with a long-term investment perspective. “Investing in mid and small caps via SIP helps in cost averaging and mitigating short-term volatility. However, given the stretched valuations in some pockets, investors should be mindful of overexposure and ensure their portfolio is well-diversified.”