Flexi-cap funds take the spotlight as small- and mid-caps falter

This shift comes as valuations remain elevated even as earnings momentum cools, prompting investors to seek safety without stepping out of equities. These schemes can move freely across large-, mid- and small-caps, without fixed allocation limits, allowing managers to shift exposure wherever valuations and opportunities look most compelling.

That flexibility appears to be driving the flow shift: net inflows into flexi-cap mutual funds jumped 27% month-on-month in October to ₹8,923 crore, according to a Mint analysis of the latest data from the Association of Mutual Funds of India (Amfi), even as overall equity inflows fell nearly 19% over the same period. Inflows into the category are now up 72% since October 2024.

The momentum has been building through the year. Steady inflows have pushed flexi-cap assets under management to about ₹5.3 trillion across 43 schemes as of October. With six launches in the past year, the category now has more schemes than any of the large-, mid- or small-cap segments, each of which hosts roughly 31-33 funds.

By contrast, large-, mid- and small-cap funds manage between ₹3.2 trillion and ₹4.1 trillion in assets, underscoring how flexi-caps have quietly pulled ahead in both scale and investor interest.

In fact, flexi-cap funds were the only category to record higher net inflows in October, even as flows into dedicated large-cap, mid-cap and small-cap funds declined, a trend not seen in at least 18 months, the analysis showed.

Flexi-cap inflows have stayed firm despite sharp volatility in recent quarters, said Satish Ramanathan, CIO-Equity at JM Financial Asset Management. “Flows should remain firm over the next two to three months, driven by steady SIPs and demand for broad all-cap exposure," he added.

The rising tilt toward flexi-caps has come as investors temper exposure to concentrated small- and mid-cap schemes and rotate part of their portfolios into hybrid schemes, debt funds and gold exchange traded funds (ETFs), noted experts.

Valuations have crowded out conviction

The valuation backdrop explains much of the hesitation. Roughly 52% of Nifty 100 stocks and 56% of Nifty Smallcap 250 names now trade above their respective five-year average price-to-earnings ratios, according to Mint’s analysis.

This narrows the scope for outsized gains in both segments amid a modest earnings outlook, noted experts. Nifty Midcap 150 constituents, however, show a near 50-50 split around long-term averages, the analysis showed. This leaves scope for “limited but reasonable" upside, said Gaurav Garg, research analyst at Lemonn Markets Desk.

Index-level valuations show a similar divide. The Nifty 100 is near its five-year average P/E of 25, the Nifty Midcap 150 trades at a 15% discount to its long-term value of 40, and the Nifty Smallcap 250 sits 17% above its five-year P/E of 27, the analysis showed.

“While the mid cap index trades below its average (P/E), it (average) was shaped by an unusually strong liquidity regime," cautioned Sonam Srivastava, founder and fund manager at Wright Research PMS. “The upside is narrower than it appears."

In short, headline index valuations may make mid-caps look relatively cheaper, but a majority of stocks across market caps still embed high earnings expectations, which are difficult to sustain in a softer demand cycle.

Srivastava noted that despite strong operational performance in Q2, India Inc's underlying demand trends remain mixed. Rural and discretionary consumption are yet to fire on all cylinders, while export-driven small caps face global headwind. "With base effects weakening from Q4, (small- and mid-cap earnings) momentum could moderate," she added.

Gaurav Didwania, partner and fund manager at Qode Advisors, argues that a large part of the small- and mid-caps (SMIDs) universe is still powered by market-share gains, supply-chain localization and industry-specific tailwinds rather than broad macro conditions. But he agrees that SMID earnings have been normalizing in recent quarters, with growth now holding up only in select pockets.

He still expects SMIDs to outperform large-cap earnings over the next 12-24 months, albeit with more volatility. But that optimism becomes harder to justify once Q2FY26 numbers are broken down.

Earnings: A cycle losing steam

The recent September-quarter profit print was shaped less by a broad-based demand upswing and more by a mix of non-core income surges at large caps, a slowdown in mid-cap core income, and low base tailwinds at smaller companies.

Mint’s analysis of 113 large-cap companies revealed that aggregate total income of big players rose about 7% year-on-year in Q2, the strongest revenue print in four quarters, while net profit jumped 43%, the highest since Q2FY24. Operational revenue grew steadily at 5%, but a 65% jump in non-core income added disproportionate heft to total income and profitability, the largest non-core income print in nine quarters.

By contrast, mid caps, comprising 156 companies, saw core income growth slow to around 9% over the past four quarters. A modest 17% rise in other income and uneven top-line momentum kept profit growth muted at 19% in Q2, the slowest among all market caps.

The small-cap cohort, with 250 companies, delivered the sharpest headline moves. Operational revenue rose 9% year-on-year, the strongest in four quarters, while a 26% increase in non-core income helped lift profits by 38%—the fastest in eight quarters, albeit off a low base.

The reliance on non-core income, combined with top-line fatigue in mid caps and base-driven gains in small caps, suggests SMID earnings are set to normalise unless broader demand revives.

Kotak Institutional Equities’ latest earnings-revision data shows downgrades outnumbered upgrades across market caps in Q2, reinforcing that earnings are normalising rather than accelerating in FY26. Around 30% of Nifty Midcap 150 and 26% of Nifty Smallcap 250 constituents faced FY26 earnings cuts of up to 5% in Q2.

Srivastava of Wright Research PMS warns that the market is sensitive to such shifts because SMIDs are priced for sustained high growth, and even a normalisation can drag returns.

Narrowing returns and market behaviour

Market action reflects this emerging disconnect between SMID earnings momentum and valuations.

In October, the Nifty 100 rose 4.3%, outpacing the 3.7% gain in the Nifty Smallcap 250 and nearly matching the 4.8% rise in the Nifty Midcap 150. Mint’s analysis over the past five years shows that SMID outperformance has steadily narrowed, reflecting a market where smaller companies generate less incremental excess return relative to large caps than in previous cycles.

Garg of Lemonn Markets Desk sees large caps outperforming SMIDs over the next 6-12 months, supported by better valuations and strong institutional interest. Even so, October mutual fund inflows show large-cap funds ceding ground to flexi-caps, as profit booking and portfolio shifts have pulled allocations lower.

Large-cap earnings also faced a narrative drag because much of the beat came from non-core income, which investors read as weaker operating leverage, added Srivastava. After strong blue-chip gains, investors have been rotating out of large caps and, in a stretched market, are also reluctant to add pure mid-cap or small-cap exposure. This makes the flexibility of flexi-cap mandates far more appealing, according to experts.

“Unless a sharp macro or market shock intervenes, the (flexi-cap) category should continue to attract healthy incremental flows, consistent with recent trends," said Ramanathan of JM Financial Asset Management.