Small-cap storm: 22 of 29 funds post double-digit losses – but long-term investors still in the green

Small-cap mutual funds have had a rough start in 2025, with 22 out of 29 funds logging double-digit losses and an average category decline of 11.72%. LIC MF Small Cap Fund was the worst hit, plunging 17.75%, followed by HSBC Small Cap Fund (-16.45%) and Motilal Oswal Small Cap Fund (-15.16%).

Despite this short-term pain with losses in the opening months of 2025, recent months have brought signs of a strong recovery. Most small-cap funds are now back in positive territory on a one-year basis, signalling a shift in market momentum.

Certified Financial Planner B Padmanaban noted that small-cap investors faced challenges in the past year due to market volatility, resulting in subdued or negative returns. However, recent months have shown a strong recovery, with the majority of small-cap funds now back in positive territory. This represents a significant shift in market momentum.

Since the beginning of 2025, small-cap mutual funds have shown a negative return of up to 18%, with an average loss of 11.72% over the same period. Out of the 29 small-cap funds in the category, 22 funds experienced double-digit losses. Among these, the LIC MF Small Cap Fund saw the highest loss at approximately 17.75%, followed by the HSBC Small Cap Fund with a loss of 16.45%, and the Motilal Oswal Small Cap Fund with a negative return of 15.16%.

Despite these challenges, there is a silver lining. Recent months have seen a strong rebound in performance, bringing most small-cap funds back into positive territory on a one-year basis. This positive trend indicates a notable shift in momentum within the category.

AMFI data for April showed a modest dip in investor appetite. Net inflows into small-cap funds declined 2.3% to ₹3,999.95 crore, while midcap fund inflows dropped 3.6% to ₹3,313.98 crore.

Still, for investors with high risk tolerance and long-term goals, small-cap funds remain a powerful tool. “These funds provide exposure to high-growth companies and often outperform over time, albeit with higher volatility,” Padmanaban said.

Padmnabhan explained when evaluating fund performance over longer horizons—2, 3, 5, 7, 10, and even 15 years—an encouraging pattern emerges. Despite the broader small-cap index still trading nearly 15% below its peak from September last year, the majority of small-cap funds have posted annualised returns well above 15%. This resilience underlines the long-term wealth creation potential of this category, particularly for disciplined investors with patience and a high-risk appetite.

He added in the context of long-term financial goals, small-cap funds play a pivotal role. They offer exposure to high-growth potential companies and often outperform larger peers over extended periods, albeit with higher volatility. Choosing to include them in your portfolio is a strategic decision that aligns with a long-term vision—one that recognises the importance of risk diversification, early entry, and compounding.

Ultimately, personal finance is a journey shaped by choices. Every investment decision carries implications—some immediate, others unfolding over time. By making informed, future-focused choices, investors can better navigate market cycles and steer their financial path toward lasting growth.

Stress tests for MFs

The March stress test conducted by AMFI (Association of Mutual Funds in India) has raised important questions about the liquidity risks in small-cap mutual funds. The test simulated how long it would take to liquidate a portion of these funds’ portfolios under normal market conditions—without creating adverse price impacts.

Results showed that it could take between 25 and 57 days to liquidate just 50% of the portfolio of several high-risk small-cap mutual funds. This indicates that while these funds offer the potential for high returns, they also come with elevated liquidity risk—especially during periods of market stress when investors may rush to redeem their units.

By regulation, small-cap funds must invest a minimum of 65% of their assets in small-cap stocks, which are generally less liquid than mid- and large-cap equities. However, several leading small-cap schemes have allocated significantly more than this minimum, increasing their exposure—and their risk.

Among the funds analysed:

Axis Small Cap Fund has the fastest liquidation potential: 25 days for 50% of its portfolio.

quant Small Cap Fund has the slowest: 63 days for 50%.

HDFC and SBI Small Cap Funds are also among the slowest to liquidate, requiring 57 days for 50%.

Notably, Tata, DSP, and HDFC Small Cap Funds have over 80% of their portfolio invested in small-cap stocks—well above the regulatory threshold.

Disclaimer: Business Today provides market and personal news for informational purposes only and should not be construed as investment advice. All mutual fund investments are subject to market risks. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.