In recent years, mid- and small-cap funds have taken centre stage in investor conversations. Their returns have been eye-catching, and many portfolios now carry a meaningful allocation to these categories. But with the excitement comes an equally important question: how much is too much?
Why investors love mid and small caps
Over the past few years, the performance of mid- and small-cap indices has been striking. On a five-year basis, midcaps and small caps have compounded at 31% and 34% respectively, far outpacing the Nifty 50’s 20% return (as of 25 June). Stretch the horizon to 10 years, and while the Nifty delivered 12%, midcaps and small caps compounded at 18% and 15%.
These numbers show why investors are drawn to these categories—in bull markets, they often produce the most thrilling stories of wealth creation.
It’s no surprise, then, that most investors feel compelled to include at least some exposure to mid- and small-caps in their portfolios. These segments provide access to fast-growing companies, often in sunrise sectors, with the potential to compound wealth at an extraordinary pace when conditions are favourable.
Why investors worry
The very qualities that make mid- and small-caps attractive also make them volatile.
To achieve that 10-year CAGR of 18% (Midcap 150) and 15% (Smallcap 250), an investor had to remain fully invested through the entire period. For midcap investors, that meant enduring a 44% fall in 2020 and a 22% fall in 2022, not to mention several other sluggish stretches. Small-cap investors faced an even bumpier ride.
The real question is: how much can you watch your portfolio fall before you give up?
Remaining invested during downturns is difficult. By nature, mid- and small-caps fall harder and faster than large-caps. Corrections can feel brutal, and recoveries often test patience. This explains why most investors don’t go all-in—the ride down can be swift and emotionally draining.
A structural shift
Beyond performance and volatility, another important shift is underway. With mid- and small-caps outperforming in recent years, money has poured into these categories at an extraordinary pace. Between 2019 and 2025, assets under management (AUM) in mid-cap funds grew more than fivefold, while smallcap funds expanded nearly 7.5 times. Large-cap funds, by contrast, haven’t even tripled.
Investor folios tell the same story. Today, there are far more folios in mid- and small-cap funds than in large-caps, something unimaginable just five or ten years ago. This reversal shows how dramatically investor preferences have tilted toward perceived high-growth categories.
For retail investors, that shift is a double-edged sword. On the one hand, it reflects a healthy appetite for opportunities beyond the safer large-cap universe. On the other, it raises red flags: such rapid inflows often signal trend-chasing and blind faith in recent winners.
Valuations in parts of the mid- and small-cap space now look stretched, leaving them vulnerable to sharp reversals if sentiment sours. What feels like a wealth-creation story today can quickly turn into wealth destruction if risks are ignored.
Staying the course
Mid- and small-caps are powerful wealth creators and deserve a place in long-term portfolios. But the risks they carry cannot be overlooked. The smarter approach is to define your allocation in advance, review it regularly, and rebalance when needed, so outperformance doesn’t leave you overexposed. Accepting drawdowns as part of the journey is crucial.
Discipline lies in sizing your exposure so you can endure volatility without abandoning your plan. Equally important is behavioural awareness: resist the urge to chase performance in buoyant markets, and avoid panic exits when corrections hit.
Ultimately, mid- and small-caps will remain the “excitement engine” of Indian equity investing. But excitement without discipline can quickly turn into regret. Balance is key—harness their growth potential while keeping risks in check. That’s how portfolios build wealth, and more importantly, help investors stay the course.
Kushal Bhagi is owner PCC Investing and a mutual fund distributor.
