Why mid and smallcap funds are essential

The most-important reason investors invest in equity mutual funds is to get superior returns. Keeping the nature of equity as an asset class in mind, all three types of equity mutual funds — large cap, midcap and smallcap funds — are expected to deliver superior returns from time to time in different market cycles, but of these, which ones have managed to deliver high alpha and superior returns and that too consistently? Let’s find out.

On a 10-year daily rolling CAGR returns basis over the past 10 years, from April 1, 2015, to December 15, 2025, Nifty 100 TRI, Nifty Midcap 150 TRI and Nifty Smallcap TRI generated >= 15% CAGR returns, 14%, 60%, and 44%, respectively, of the entire period. In the same period on a 10-year CAGR returns basis, the midcap and smallcap indices outperformed the large cap index 98% and 69%, respectively, of the time.

Data at the index level proves that mid and smallcap indices have consistently delivered superior returns and have outperformed much higher number of times, compared to the large cap index, over the long term.

Now, many may be curious about the data of active funds within the large, mid and smallcap categories. Based on the same parameters at the category average level, on a 10-year daily rolling CAGR returns basis over the past 10 years, from April 1, 2015, to December 15, 2025, Large Cap Active Funds, Mid Cap Active Funds and Small Cap Active Funds generated >= 15% CAGR returns, 10%, 60%, and 64%, respectively, of the entire period. In the same period on a 10-year CAGR returns basis, active midcap and smallcap funds outperformed active large cap funds 100% and 97%, respectively, of the time.

Data at the active fund category average level too proves that active mid and smallcap funds have consistently delivered superior returns and have outperformed much higher number of times compared to active large cap funds over the long term.

A key point of observation is that active mid and smallcap funds have done far better in terms of delivering consistent superior returns and outperformance. The average outperformance of active mid and smallcap funds vs active large cap funds have been 3.9% and 4.4%, respectively.

This clearly answers the question “why mid and smallcap funds are a must to have in one’s portfolio to achieve superior returns?” and clearly indicates that if investors want to generate alpha and superior returns, they will need to invest in the mid and smallcap categories.

Today, although the headline inflation in India is very low at just 0.71%, one should not forget that there are many areas like healthcare, education, travel, branded items, leisure services, etc., where annual inflation can range 12-15%. And the only way to beat this high inflation figure, particularly post taxation, is to have decent exposure towards mid and smallcaps. This is another important reason why one should look at investing in mid and smallcaps.

Investing in mid and smallcaps look lucrative, but there are two points that investors should bear in mind:

1. Large caps should not be completely ignored.

2. Investing in mid and smallcaps is not meant for the weak-hearted. All three market capitalisations (large, mid, and small) will perform in cycles. As per historical data, mid, and smallcaps have been extremely volatile and cyclical, especially in the short to medium term, compared to large caps, which have provided stability and thus, it is wise even for a highly-aggressive investor to have anywhere between 25% and 50% exposure towards large caps.

Now, many may ask will mid and smallcaps continue to deliver high alpha and superior returns in future? The answer is yes. Here is why – India is an emerging economy with a high GDP growth rate at 8.2% in Q3CY2025, aggregate Q2FY26 earnings growth of Nifty Midcap 150 and Nifty Smallcap 250 have been very strong at 27% and 37% YoY, respectively, and the universe of mid and smallcap companies is vast, giving fund managers ample opportunities to choose the right high growth stocks. Thus, with the current time and valuation correction in the equity markets, if the Indian economy and corporate earnings continue to generate high growth, there seems to be no reason to believe why mid and smallcaps would not deliver superior returns over the long term.

Investing in mid and smallcaps can be done via SIPs and/or lumpsum. The trick to generate higher returns and minimise volatility and cyclicality risks is to invest during price, time, and/or valuation correction pockets and by being patient for the long term (8-10 years).

(The writer is the founder of Rupee With Rushabh Investment Services)