Small-cap funds lead mutual fund performance; inflows hit one-year high

Small-cap mutual funds have staged a strong comeback in recent months amid market uncertainty, significantly outperforming their mid-cap and large-cap counterparts. Data for the three months ended May 31 shows that small-cap funds delivered an average return of 7.76%, compared with 3% for mid-cap funds, while large-cap funds posted an average loss of 4%.

The stellar performance has reignited investor interest in the category, according to LiveMint report. According to data from the Association of Mutual Funds in India (AMFI), small-cap funds attracted net inflows of Rs 16,885 crore in April, the highest monthly inflow into the category in the past year.

Performance data highlights both the opportunities and risks associated with small-cap investing. As of May 31, small-cap funds generated an average return of 3.13% over six months and 6.42% over one year. Their long-term track record remains considerably stronger, with category-average annualised returns of 19.4% over the past three years.

Fund managers have also demonstrated a strong ability to outperform benchmarks, says the LiveMint report. Nearly 92.3% of actively managed small-cap funds have beaten the Nifty Smallcap 250 Total Return Index (TRI) over the last decade. The outperformance trend continues over shorter periods as well, with 81.8% of funds beating the benchmark over five years and 80% doing so during the past 12 months.

However, experts caution that small-cap funds are best suited for investors with a long investment horizon. Historical rolling-return analysis of the Nifty Small Cap 100 Index since April 2004 shows that the likelihood of negative returns declines significantly as the holding period increases.

For investors making systematic investment plan (SIP) investments, the worst three-year outcome has been a loss of 44%. Extending the investment period to five years improves the worst-case return to a decline of 16.3%. Over a 10-year horizon, the worst SIP return narrows sharply to a loss of just 2.4%. Investors who stayed invested for 15 years or longer have historically earned a minimum annualised return of 6.1%.

The data reinforces a key lesson for investors: while small-cap funds can be volatile in the short term, patience and a long-term approach have historically improved the odds of generating positive returns.