This marks a rebound after more than two years of underperformance during a strong rally in smallcap stocks.
Most active equity schemes outperformed their benchmarks over the past year, offering some relief to investors battered by a volatile equity market.
Smallcap funds, which hold the largest number of investor accounts, led the gains relative to their benchmarks.
As of September 8, 23 of 28 schemes posted higher returns than the Nifty Smallcap 250 TRI (Total Return Index), which fell 7 per cent.
The outperformance gap is even wider against the BSE 250 SmallCap TRI, which declined 7.7 per cent.
This marks a rebound after more than two years of underperformance during a strong rally in smallcap stocks.
Ashwin Patni, head of wealth management solutions at Julius Baer India, said this performance trend lines up with expectations.
"In 2024, many smallcap index constituents rallied sharply, even when fundamentals didn't justify such gains. In one-directional bull markets, active funds often lag their benchmarks," he explained.
"In a sideways market, as seen over the past year, active funds have a better chance of generating alpha because their portfolios focus on fundamentally sound stocks.
"In the past year, smallcap average returns (direct schemes) were around minus 5 per cent as of September 5, delivering roughly 4 per cent alpha versus the BSE 250 SmallCap TRI."
Experts say the rebound also reflects strong performance from largecap holdings within active smallcap funds.
Unlike benchmarks, which focus solely on smallcaps, these funds maintain significant largecap exposure -- a factor that had previously weighed on returns before the market correction in September 2024.
Fund managers' stock selection and timely cash allocations further buttressed outperformance in select schemes across categories.
Nearly 60 per cent of largecap schemes outperformed the Nifty 100 TRI, though the margin of outperformance was narrower than in recent years.
Over three years, the outperformance ratio rises to 79 per cent.
Among midcap funds, 21 of 29 schemes exceeded their benchmarks over one year, while 26 of 40 flexicap schemes did the same.
Experts also highlighted improved market breadth as a contributing factor.
Market breadth has strengthened, with nearly two-thirds of National Stock Exchange-listed companies delivering gains in the past 12 months, compared with just a third in the previous year.
This trend favours managers who rely on stock-picking rather than passive index tracking.
Smallcap funds' relative strength is unsurprising, given the broader universe of potential investments.
"A key driver of smallcap mutual funds' gains is the wider opportunity set and active stock selection. The benchmark is confined to 250 constituents, but funds can explore far more options," observed Sriram B K R, senior investment strategist at Geojit Financial Services.
"Active managers in flexicap and smallcap funds benefit from the freedom to take high-conviction positions.
"This latitude to deviate meaningfully from the benchmark and identify unpriced opportunities has allowed these funds to consistently generate alpha, highlighting the value of active management in concentrated indices," said Rishabh Nahar, partner and fund manager at Qode Advisors.
Feature Presentation: Ashish Narsale/Rediff