Small-Cap funds get 44% of equity inflows despite high valuations: Should investors be worried?

Small- and mid-cap mutual funds continue to attract a significant share of investor money despite trading at substantial valuation premiums to large-cap stocks, raising questions about whether investors are taking on excessive risk in pursuit of higher returns. Small- and mid-cap funds attracted ₹16,873 crore, accounting for 44% of equity mutual fund inflows in September 2026, even as valuations in both segments remained elevated relative to large caps, according to Groww Capview’s September market review.

The report, titled Paid to Wait, said equity fund inflows increased 31% to ₹38,307 crore in September. Small-cap funds received ₹9,039 crore, followed by mid-cap funds at ₹7,835 crore, while flexi-cap funds attracted ₹6,702 crore. Large-cap funds received just ₹859 crore.

The divergence between fund flows and valuations is significant because small- and mid-cap stocks have already outperformed large caps over the past year, leaving investors exposed to the risk of a valuation correction if earnings fail to justify current prices.

Small- and mid-cap stocks remain expensive

Groww Capview’s analysis shows that the Nifty Smallcap 250 traded at a forward price-to-earnings (P/E) multiple of 23.6 times in September 2026, compared with 25 times in September 2024. Despite the decline, small caps traded at a 34% premium to large caps, against a 10-year average discount of 11%.

The Nifty Midcap 150 traded at 25.8 times forward earnings, down from 35.6 times in September 2024. However, mid-caps continued to command a 47% premium to large caps, significantly above their 10-year average premium of 19%.

The report also highlighted the difference in recent market performance. While the Nifty 50 declined 7.1% over the year to September 30, 2026, the Nifty Midcap 150 gained 4.6% and the Nifty Smallcap 250 rose 7.2%.

Small- and Mid-Cap Funds: Inflows, Valuations and Returns

This relative resilience may help explain why investors continue to favour smaller companies. However, the report cautioned that small-cap valuations have corrected far less than those of large caps from their 2024 peaks.

Could investors be taking on too much risk?

Groww Capview noted that small- and mid-cap stocks have historically experienced sharp relative declines after periods of elevated valuations. Following the market peaks of 2007, 2010 and 2017, small caps lost a median 30% against large caps over the subsequent two years.

The report also pointed out that the usual small-cap rebound pattern may not offer the same opportunity this time. Although smaller companies often outperform after large-cap corrections, mid- and small-cap stocks had already rebounded strongly from the February 2025 market low.

This does not mean small-cap funds are necessarily headed for losses. However, high valuations can leave less room for disappointment if corporate earnings weaken or market sentiment deteriorates.

Investors should therefore assess their exposure based on investment horizon, risk tolerance and portfolio concentration rather than recent fund returns alone.

Why Groww prefers large caps

Groww Capview recommends overweighting large-cap stocks, which it considers more attractive on valuations. The report advises investors to remain selective in mid- and small-cap segments, favouring actively managed funds over passive strategies.

For investors deploying fresh money, it recommends building large-cap exposure gradually over three or four tranches across three months instead of investing the entire amount at once.

The central message is that strong inflows do not necessarily indicate attractive valuations. With a substantial share of investor money flowing into smaller stocks despite their valuation premiums, investors may need to prioritise portfolio balance and avoid chasing recent performance.

The report’s recommendation is not to abandon small- and mid-cap funds, but to be more selective about exposure while using large caps as the core of an equity portfolio.