'Stopping now would defeat the core purpose of an SIP, which is to average out the purchase cost over market cycles.'
Inflows into midcap funds fell 25 per cent year-on-year in October to Rs 3,807 crore, while smallcap fund inflows dropped 20 per cent to Rs 3,476 crore.
After two strong years (2023 and 2024), returns have been subdued this year.
Experts say long-term investors should remain patient and stay invested through the current phase.
Why have flows slowed?
Net inflows across equity categories declined in October, with open-ended equity inflows falling 19 per cent month-on-month.
Largecap funds saw a 58 per cent decline and multicap funds 30 per cent.
"The decline is part of a broader market-wide moderation in inflows into equities. It does not reflect a shift in sentiment against mid and smallcap funds specifically," says Piyush Gupta, director-financial services, Crisil Intelligence.
Profit booking by lump-sum investors also contributed.
"Inflows via SIPs (Systematic Investment Plans) remain steady. Lump-sum investors may be booking profits and shifting their money to gold and multi-asset funds that have done well this year," says Sandeep Bagla, CEO, TRUST Mutual Fund.
"Anecdotal evidence also suggests that many people are taking money out of financial assets and investing it in real estate," adds Bagla.
High valuations and economic sluggishness, Bagla explains, may have also played a role.
Exposure to faster-growing segments
Investors should have exposure to mid and smallcap funds because many fast-expanding sectors and newly listed companies fall in this universe.
Infrastructure, for instance, has only a handful of largecap stocks but around 70 in mid and smallcap segment.
"By restricting themselves to large caps, investors would miss out on this growth," says Bagla.
"By holding these funds over a longer horizon, investors can generate higher returns and build wealth," says Gupta.
Volatility and liquidity risk
Mid and smallcap funds are riskier than their largecap counterparts.
"Higher volatility in these funds can lead to sharper drawdowns during corrections," says Aditya Agarwal, cofounder, Wealthy.in.
Lower liquidity makes it harder for fund managers to execute large trades without price impact.
The earnings of these stocks tend to be less stable.
"Macroeconomic conditions, competition from larger players, or overreliance on a few large customers can impact their profitability," says Nilesh D Naik, head of investment products, Share.Market.
Smaller businesses may lack strong governance structures.
Remember, however, that midcap funds tend to be less risky than smallcap funds.
Enter with long horizon
Investors with at least two to three years of market experience may enter these funds, but with a longer horizon due to their elevated valuations (relative to large caps).
"The investment horizon should be at least five to seven years as the probability of negative outcomes diminishes with a longer holding period," says Gupta.
He cites five-year rolling returns data with daily shifts over 15 years ending October 2025, which showed that returns were above 10 per cent in 92 per cent of observations.
Decide allocation
Set clear exposure limits before investing.
"All investment or redemption decisions should be guided by this framework and not by greed or fear," says Naik.
Agarwal recommends investing via SIPs instead of lump sums currently.
He suggests allocating 15 to 30 per cent of the equity portfolio to these funds as part of the satellite allocation.
Naik cautions that even high-risk investors should not allocate more than 20 per cent to smallcap funds.
Keep investing
SIPs benefit from lower prices during downturns.
"Stopping now would defeat the core purpose of an SIP, which is to average out the purchase cost over market cycles," says Agarwal.
Long-term investors should treat underperformance relative to large caps as a buying opportunity.
Existing investors should ensure their allocation stays aligned with their target mix.
"If allocation to a particular fund category is higher than the pre-decided level, investors may stop SIPs there," says Naik.
Finally, prefer active funds in this space.
"Unlike largecap funds where returns often track the index, a skilled mid or smallcap fund manager can generate significant alpha through superior stock selection, especially during downturns," says Agarwal.
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Feature Presentation: Ashish Narsale/Rediff