MUMBAI: Small- and mid-caps are drawing investors back after a bruising start to 2026, even as blue chips remain under pressure. After January’s record ₹5,191.06 crore redemption, small-cap funds saw inflows of ₹3,881.06 crore in February, prompting fund houses to launch new schemes and reopen existing ones.
The opportunity is real, but so are the risks. Experts warn that low liquidity, stretched valuations, and governance weaknesses can turn potential gains into sharp losses.
“The runway is huge and positive, but the interim perils are also real,” remarked Harsh Gupta Madhusudan, fund manager-PIPE, Ionic Asset.
Following this renewed interest, ICICI Prudential Mutual Fund reopened subscriptions to its Small Cap Fund in January, Groww Mutual Fund launched a new small-cap scheme around the same time. The Wealth Company Mutual Fund launched its Small Cap Fund on 4 March, and Abakkus Mutual Fund, backed by Sunil Singhania, ran its new fund offer from 26 February to 12 March.
Despite the recent rise, inflows remain below the peak of ₹6,484.43 crore hit in July 2025, the highest since January 2024.
High returns, high risks
Early signs of a rebound are encouraging, but market participants caution that gains can be quickly reversed under stress.
Madhusudan highlighted the difficulty of quickly selling assets during a crisis and the psychological stress caused by “exaggerated mark to market potential losses” during market downturns.
“Given low liquidity, small balance sheets and business concentration, volatility can be sharp, making disciplined positioning and exit planning critical,” added Hari Shyamsunder, vice president and senior institutional portfolio manager–India Equities, Templeton Global Investments.
As more money crowds into a limited set of stocks, both gains and losses are amplified. Sharp drawdowns can trap investors, underscoring that chasing momentum in small-caps without caution can turn high-return expectations into significant losses, experts say.
The same factors that make small-caps exciting—low visibility, high growth, and limited liquidity—also make them dangerous when the cycle turns.
The risks in small- and micro-cap stocks stem from the fact that many companies don’t tick key boxes, said Vinay Jaising, chief investment officer and head of equity advisory at ASK Private Wealth. Many lack a robust business model or a strong balance sheet. Higher debt levels make them vulnerable to interest rate cycles, and unstable shareholding patterns, including pledged shares, increase risk in volatile markets.
“In some cases, overhang linked to potential PE Exits (PE owners who may want to exit, especially if their fund-life or multi-year investment cycle is ending) could also put drawdown pressure,” Jaising highlighted, but added that this scenario could be used as a long-term investment opportunity if one is constructive on the business moat of the company.
Jaising said that besides fundamentals, margin of safety and his macro view, he also checks a stock’s average daily liquidity before investing. “The transaction price impact of selling a large position in small and microcaps needs to be understood before one takes a sizable position, and hence margin of safety is key.”
According to Lokesh Manik, senior analyst at Vallum Capital, over long periods, small-caps have delivered returns comparable to larger peers, though with meaningfully higher volatility. “That volatility stems less from business fragility alone and more from illiquidity and shifting economic conditions.”
He said that periods of strong growth often reward patient small-cap investors, while governance standards have improved materially through tighter regulation, GST-led formalization, and better technology-driven disclosure.
External headwinds, however, could complicate recovery. Surging energy and oil prices, LPG shortages, and supply disruptions linked to the Iran-US conflict may delay earnings recovery across large, mid-, and small-caps, analysts said.
Strong selling by foreign institutional investors (FIIs) has concentrated on large caps, prompting some domestic investors to hunt for value in smaller companies. But Madhusudan cautioned that if broader selling accelerates due to higher oil prices or prolonged geopolitical tensions, the small-cap segment could also become vulnerable in the short term.
So far in 2026, the Nifty 50 has dropped nearly 13%, while the Nifty Smallcap 250 has declined by over 12%, reflecting both renewed investor interest and lingering volatility. In 2025, the Nifty 50 climbed 10.5%, while the Nifty Smallcap 250 slipped 6%.