Mid- and Small-Cap Mania: Why Retail Investors Need to Rebalance Toward Large Caps

By Dr. Vikas Gupta, CEO & Chief Investment Strategist, OmniScience Capital

Latest Industry Trends
Recent data from the Indian mutual fund industry reinforces the trend of retail overweight in mid- and small-cap funds. In August 2025, equity funds attracted ₹33,430 crore in net inflows, while SIP contributions held steady at ₹28,265 crore.

Despite a slight dip in total assets under management (₹75.18 lakh crore vs. ₹75.36 lakh crore in July) due to market corrections, investor engagement remained strong, with 15 lakh new folios added and retail folios in equity, hybrid, and solution-oriented schemes rising to 19.64 crore.

Category-wise flows show flexicap funds leading (₹7,679 crore), followed by mid-caps (₹5,331 crore) and small-caps (₹4,993 crore), while large-cap inflows gained momentum at ₹2,640 crore—a 33% rise from July.

Gold and silver ETFs also saw significant interest, drawing ₹7,200 crore and ₹1,759 crore respectively. These numbers highlight that while investors continue chasing high-growth segments, some rotation into safer large caps and commodities is emerging, reflecting an evolving approach to portfolio allocation.

A Dangerous Imbalance
Indian retail investors have fallen into a dangerous trap: they’re dramatically overweight in mid- and small-cap stocks just as valuations have reached alarming levels.

Recent mutual fund data from AMFI reveals a structural misalignment that threatens portfolio stability and long-term returns.
While flexicap schemes dominate retail inflows—benefiting from managers’ flexibility to invest across market capitalizations—pure category flows tell a troubling story.

The total Assets Under Management (AUM) in large-cap funds now trails mid-cap funds and barely exceeds small-cap funds, despite large caps representing approximately 70% of India’s total market capitalization.

This allocation mismatch becomes stark when compared to market reality: large caps should dominate portfolios, while mid-caps (15–20% of market cap) and small caps (10–15%) warrant proportionally smaller allocations. Instead, retail investors have inverted this structure, creating significant concentration risk.

Valuation Warning Signals

Current Price-to-Earnings (PE) multiples underscore the severity of this misallocation:

• Nifty Midcap 50 → PE of 37
• Nifty Midcap Select → PE of 47
• Nifty Smallcap 250 → PE of 33
• Nifty 50 (Large caps) → PE of 22

In other words, midcaps are priced at nearly double the Nifty 50’s valuation, and select indices trade at more than twice the level. These numbers reveal that investors aren’t just overweighting smaller caps—they’re doing so at historically expensive valuations. This magnifies downside risk if earnings growth fails to meet expectations.

The Performance-Chasing Trap

Years of outsized returns from mid- and small-cap indices have triggered intense FOMO (Fear of Missing Out), driving flows toward the most expensive segments of the market.

In Q1 2025 alone, ₹20,255 crore poured into mid- and small-cap funds. By July, small-cap inflows surged 61% month-on-month, while mid-caps rose 38%. Large caps, in contrast, managed only 25.5%—even as the Nifty 50 declined.

A brief reversal came in August, when large-cap inflows rose 33% while small-cap inflows plunged 23%. But this hasn’t corrected the underlying overweight. Retail investors remain structurally tilted toward smaller caps, highlighting their trend-chasing tendencies.

Why This Matters

This imbalance isn’t just a numbers game; it has real consequences for portfolios:

• Market Structure Misalignment: Underweighting large caps means portfolios don’t reflect India’s actual equity market composition, creating unnecessary fragility.

• Elevated Valuation Risk: With mid- and small-caps trading at 33–47 PE ratios, investors are paying steep premiums for uncertain future growth. Large caps at 22 PE offer more reasonable entry points.

• Amplified Volatility: Smaller caps historically experience deeper drawdowns during corrections. Overexposure will magnify losses when markets turn.

• Reversal Risk: Just as performance-chasing drove flows into smaller caps, underperformance can trigger rapid exits, leaving retail investors holding overvalued positions.

The Scientific Investing Solution
At OmniScience, our Scientific Investing framework addresses these risks through systematic screening that eliminates:

• Capital Destroyers → Highly indebted or loss-making companies
• Capital Eroders → Businesses with weak competitive advantages and low ROE
• Capital Imploders → Fundamentally sound but overpriced companies

Only Capital Multipliers—companies with sustainable growth, strong fundamentals, and reasonable valuations—qualify for investment.

Viewed through this lens, many mid- and small-cap favorites today fall into the Capital Imploder category due to stretched valuations. Conversely, large caps offer more Capital Multiplier opportunities: established businesses with stronger balance sheets, global competitiveness, and attractive valuations.

Strategic Action Plan

1. Realign Allocations: Match portfolio weights to the actual market cap structure. Large caps should form the foundation.

2. Prioritize Valuation: Resist chasing high-PE segments. Focus on companies trading at reasonable multiples with sustainable growth prospects.

3. Maintain Disciplined Diversification: Keep exposure across caps but weighted appropriately to market share and risk-return profiles.

4. Leverage Systematic Investing: Use SIPs to mitigate timing risks and average out volatile valuations.

5. Embrace Long-term Thinking: Ignore short-term performance trends. Focus instead on intrinsic value and sustainable advantages.

The Bottom Line
Today’s retail investment landscape shows clear signs of speculative excess, with dangerous overweights in expensive mid- and small-cap stocks. While these segments may continue their runs in the near term, history suggests such imbalances eventually correct.

Large caps—though less glamorous—offer superior stability, stronger fundamentals, and currently more attractive valuations. Investors who adopt evidence-based allocation strategies and prioritize capital preservation alongside growth will be better positioned for the inevitable rebalancing ahead.

Scientific Investing is about anticipating risks before they become losses. The time to rebalance is now—not after the correction.
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Disclaimer
The views expressed are those of Dr. Vikas Gupta in his professional capacity as CEO & Chief Investment Strategist at OmniScience Capital. This article is for informational and educational purposes only and should not be construed as investment advice. Past performance is not indicative of future results. Investors should consult a licensed financial advisor before making investment decisions.