Small-cap mutual funds have had a bumpy start to 2025, with 22 out of 29 funds posting double-digit losses. The category experienced an average decline of 11.72% during the opening months, with LIC MF Small Cap Fund emerging as the biggest loser at -17.75%, followed by HSBC Small Cap Fund (-16.45%) and Motilal Oswal Small Cap Fund (-15.16%).
Despite this rocky start, the tide seems to be turning. Recent months have shown a strong rebound in performance, and most small-cap funds are now back in the green on a one-year basis. This signals a significant shift in market momentum, offering some relief to long-term investors.
Certified Financial Planner B Padmanaban acknowledged the short-term pain caused by market volatility, which impacted investor returns in the small-cap segment. However, he emphasized that the recent recovery is a promising sign. “Despite the broader small-cap index still trading nearly 15% below its peak from September last year, most small-cap funds have delivered annualised returns above 15% over longer periods,” he noted. This trend highlights the resilience and long-term wealth-building potential of these funds.
Padmanaban further pointed out that for investors with high-risk tolerance and long-term goals, small-cap mutual funds remain a strategic investment avenue. Their ability to deliver outsized returns over time makes them attractive, even though they come with higher volatility. These funds typically provide exposure to high-growth companies that can outperform larger peers across extended investment horizons.
While optimism is growing, recent data from AMFI (Association of Mutual Funds in India) showed a slight dip in investor enthusiasm. Net inflows into small-cap mutual funds dropped 2.3% in April to ₹3,999.95 crore, with mid-cap fund inflows also declining by 3.6% to ₹3,313.98 crore.
Another area of concern highlighted in AMFI’s March stress test was liquidity risk. The test simulated the time it would take to liquidate 50% of various small-cap funds under normal market conditions, without creating adverse price movements. Findings showed that liquidation could take anywhere from 25 to 63 days, depending on the fund. Axis Small Cap Fund had the quickest liquidation period at 25 days, while quant Small Cap Fund was the slowest, requiring 63 days. HDFC and SBI Small Cap Funds also featured among the slowest, each needing 57 days to liquidate half their holdings.
This liquidity challenge stems from the regulatory requirement that small-cap funds must invest at least 65% of their assets in small-cap stocks, which are typically less liquid than larger equities. Notably, several top-performing funds like Tata, DSP, and HDFC Small Cap Funds have taken even larger exposures, with over 80% of their portfolios invested in small-cap stocks, further increasing their risk during volatile periods.
Ultimately, small-cap funds are a double-edged sword—offering potential for high long-term gains while demanding greater risk tolerance, discipline, and patience. As Padmanaban rightly concludes, personal finance is a journey shaped by informed choices. Investors who stay focused on their long-term goals and make calculated decisions can better navigate market ups and downs and unlock substantial growth over time.
Disclaimer: This article is for informational purposes only and should not be taken as investment advice. Mutual fund investments are subject to market risks. Please consult a qualified financial advisor before making any investment decisions.
