Mid and Small Cap valuations have corrected? Why broader markets still offer upside, Aditya Khemani of Invesco MF explains
Aditya Khemani, Fund Manager at Invesco Mutual Fund, shares his views on valuations, market outlook, key sectors, risks, and portfolio strategy for retail investors
- Feb 4, 2026,
- Updated Feb 4, 2026 4:25 PM IST
After a strong post-pandemic rally, Indian equity markets have entered a phase of consolidation, leaving many retail investors unsure about where to deploy fresh money. Mid and small cap valuations looked stretched, returns over the past year have been muted, and global uncertainty remains high.
In this environment, disciplined stock selection, realistic return expectations, and diversification have become more important than ever. In this interaction with BT, Aditya Khemani, Fund Manager—Equity at Invesco Mutual Fund, shares his views on valuations, market outlook, key sectors, risks, and portfolio strategy for retail investors.
What are the key takeaways for the markets from this Budget and which sectors do you think are likely to benefit the most?
Aditya Khemani: With the rollout of GST regime, the importance of the Budget has been coming down over the years. It holds importance for areas like direct taxes, capital gains, etc. And with this year’s Budget, the message is the government is committed to moving in the direction of strengthening the economy through consistent policy actions.
So, they continue to walk the path of fiscal consolidation by reducing the fiscal deficit slowly and gradually every year, steady focus on capex and infrastructure creation. And they are managing the finances well with a steady balancing between different areas.
For example, they are dissuading areas like tobacco consumption, excess speculation in the derivatives markets by increasing the taxation on these and using them in productive areas like capex and infrastructure creation. So, in our view, there is not any one particular sector which will benefit but the economy as a whole will be steady through consistent policy actions. And this should indirectly benefit all sectors.
Q). How do you see current valuations in Indian equities, especially in mid- and small-cap stocks? In this environment, where should retail investors consider putting fresh money?
Khemani: In case one looks at the aggregate index on the small and mid-cap side, the Midcap Index (BSE Midcap 150 Index) trades around 23 times one-year forward earnings and the Small Cap Index (BSE Smallcap 250 Index) trades around 19 times around one year forward earnings. So, on an aggregate this will be at slight premium to the last 10-year historical valuations.
But within these indexes, because of the sharp rally which happened from 2020 start to 2024 September, market rerated most companies which were showing decent earnings growth and hence lot of companies started trading at valuations which were much higher than their business models.
Large part of that mispricing has got corrected over the last 15-16 months. And in our view, it is much easier than it was over the last few years to identify companies that look attractive for the medium to long term. But since, we are going through slight downward reset in growth expectations for corporate India due to a variety of factors one should keep their return expectations realistic around early teens rather than the 2000-2024 period when the earnings growth was much higher leading to higher stock price returns.
Q). For new investors, which themes or sectors should be considered as core long-term holdings?
Khemani: On a broader sector point of view, some of the evergreen core long-term sectors we like would be consumption, financials and healthcare. And some of the themes we like are retailing, quick commerce, hospitals, pharma contract manufacturing (CDMO), real estate, aviation, electronic manufacturing and financialisation.
Q). How should investors think about portfolio diversification across market caps in the current environment?
Khemani: One thing last year has taught us is, to be diversified across asset classes and market caps rather than putting everything in one basket. And this will help us have a much more consistent return and experience lower volatility rather than the volatility associated with one asset class or one market cap.
Hence, our message to investors is to first diversify across asset class depending on one’s financial goals and secondly within equity, diversify across large cap, mid cap and smallcaps. One can do this by investing into funds in different market caps separately or by investing into categories like flexicaps/large & midcaps/multicaps which is forced to put into all market caps.
Q). Are there any sectors currently out of favour that could offer attractive opportunities if a recovery plays out?
Khemani: As a house, our view is that there will be a gradual recovery in the economy over the next 12-18 months. And some of the sectors which could benefit would be consumer discretionary sector, real estate sector and banking sector. As some of these sectors are very macro driven and domestic consumption led there will be positive effect of gradual macro recovery and hence we remain positive on these.
Q). What key risks should retail investors watch out for in 2026, especially in mid- and small-cap stocks amid global uncertainty?
Khemani: Few of the global risks that equities face are 1. Geopolitical tensions in different parts of the world, 2. Policies of Mr Trump including resolution on tariffs as this is leading to lot of uncertainty everywhere. And also, how does US Dollar behave as that has an impact on money flows globally.
Plus, on the domestic front, India is going through a phase of cyclical slowdown leading to some impact on macro variables like currency depreciation due to foreign money outflows, etc. So ultimately the key would be corporate earnings growth and in case one sees further slowdown then chances of equity market recovery would be difficult.
Q). The Sensex, Midcap, and Smallcap indices have delivered muted returns over the past year. What is your outlook for 2026, and which market segments appear better positioned to deliver stronger performance?
Khemani: If we go back into history, we will see that equity markets performance is never linear even though returns will look very attractive over the long term. So just to give a context, last 10 years annualised return on the large cap index (Nifty 100 Index) has been around 13%, mid cap index (BSE Midcap 150 Index) has been around 18% and small cap index (BSE Small cap 250 Index) around 15%.
So, this looks very attractive but if one digs further, one will see annual returns to be very volatile with negative returns in lot of years. So, the last 15-16 months has been a weak phase for the broader markets after great returns between 2020-2024. And in this phase, market has corrected mispricing for many companies though there will be pockets which still trade expensive for its business model.
But earnings compounding continues for lot of good companies and in case one takes a medium-term three-year view rather than one-year short term view, it looks like broader markets should go back to early double digits to teens annualised returns. But then it will be a stock pickers market, and one needs to be very focused in terms of themes and companies.
After a strong post-pandemic rally, Indian equity markets have entered a phase of consolidation, leaving many retail investors unsure about where to deploy fresh money. Mid and small cap valuations looked stretched, returns over the past year have been muted, and global uncertainty remains high.
In this environment, disciplined stock selection, realistic return expectations, and diversification have become more important than ever. In this interaction with BT, Aditya Khemani, Fund Manager—Equity at Invesco Mutual Fund, shares his views on valuations, market outlook, key sectors, risks, and portfolio strategy for retail investors.
What are the key takeaways for the markets from this Budget and which sectors do you think are likely to benefit the most?
Aditya Khemani: With the rollout of GST regime, the importance of the Budget has been coming down over the years. It holds importance for areas like direct taxes, capital gains, etc. And with this year’s Budget, the message is the government is committed to moving in the direction of strengthening the economy through consistent policy actions.
So, they continue to walk the path of fiscal consolidation by reducing the fiscal deficit slowly and gradually every year, steady focus on capex and infrastructure creation. And they are managing the finances well with a steady balancing between different areas.
For example, they are dissuading areas like tobacco consumption, excess speculation in the derivatives markets by increasing the taxation on these and using them in productive areas like capex and infrastructure creation. So, in our view, there is not any one particular sector which will benefit but the economy as a whole will be steady through consistent policy actions. And this should indirectly benefit all sectors.
Q). How do you see current valuations in Indian equities, especially in mid- and small-cap stocks? In this environment, where should retail investors consider putting fresh money?
Khemani: In case one looks at the aggregate index on the small and mid-cap side, the Midcap Index (BSE Midcap 150 Index) trades around 23 times one-year forward earnings and the Small Cap Index (BSE Smallcap 250 Index) trades around 19 times around one year forward earnings. So, on an aggregate this will be at slight premium to the last 10-year historical valuations.
But within these indexes, because of the sharp rally which happened from 2020 start to 2024 September, market rerated most companies which were showing decent earnings growth and hence lot of companies started trading at valuations which were much higher than their business models.
Large part of that mispricing has got corrected over the last 15-16 months. And in our view, it is much easier than it was over the last few years to identify companies that look attractive for the medium to long term. But since, we are going through slight downward reset in growth expectations for corporate India due to a variety of factors one should keep their return expectations realistic around early teens rather than the 2000-2024 period when the earnings growth was much higher leading to higher stock price returns.
Q). For new investors, which themes or sectors should be considered as core long-term holdings?
Khemani: On a broader sector point of view, some of the evergreen core long-term sectors we like would be consumption, financials and healthcare. And some of the themes we like are retailing, quick commerce, hospitals, pharma contract manufacturing (CDMO), real estate, aviation, electronic manufacturing and financialisation.
Q). How should investors think about portfolio diversification across market caps in the current environment?
Khemani: One thing last year has taught us is, to be diversified across asset classes and market caps rather than putting everything in one basket. And this will help us have a much more consistent return and experience lower volatility rather than the volatility associated with one asset class or one market cap.
Hence, our message to investors is to first diversify across asset class depending on one’s financial goals and secondly within equity, diversify across large cap, mid cap and smallcaps. One can do this by investing into funds in different market caps separately or by investing into categories like flexicaps/large & midcaps/multicaps which is forced to put into all market caps.
Q). Are there any sectors currently out of favour that could offer attractive opportunities if a recovery plays out?
Khemani: As a house, our view is that there will be a gradual recovery in the economy over the next 12-18 months. And some of the sectors which could benefit would be consumer discretionary sector, real estate sector and banking sector. As some of these sectors are very macro driven and domestic consumption led there will be positive effect of gradual macro recovery and hence we remain positive on these.
Q). What key risks should retail investors watch out for in 2026, especially in mid- and small-cap stocks amid global uncertainty?
Khemani: Few of the global risks that equities face are 1. Geopolitical tensions in different parts of the world, 2. Policies of Mr Trump including resolution on tariffs as this is leading to lot of uncertainty everywhere. And also, how does US Dollar behave as that has an impact on money flows globally.
Plus, on the domestic front, India is going through a phase of cyclical slowdown leading to some impact on macro variables like currency depreciation due to foreign money outflows, etc. So ultimately the key would be corporate earnings growth and in case one sees further slowdown then chances of equity market recovery would be difficult.
Q). The Sensex, Midcap, and Smallcap indices have delivered muted returns over the past year. What is your outlook for 2026, and which market segments appear better positioned to deliver stronger performance?
Khemani: If we go back into history, we will see that equity markets performance is never linear even though returns will look very attractive over the long term. So just to give a context, last 10 years annualised return on the large cap index (Nifty 100 Index) has been around 13%, mid cap index (BSE Midcap 150 Index) has been around 18% and small cap index (BSE Small cap 250 Index) around 15%.
So, this looks very attractive but if one digs further, one will see annual returns to be very volatile with negative returns in lot of years. So, the last 15-16 months has been a weak phase for the broader markets after great returns between 2020-2024. And in this phase, market has corrected mispricing for many companies though there will be pockets which still trade expensive for its business model.
But earnings compounding continues for lot of good companies and in case one takes a medium-term three-year view rather than one-year short term view, it looks like broader markets should go back to early double digits to teens annualised returns. But then it will be a stock pickers market, and one needs to be very focused in terms of themes and companies.