Despite high valuations, small and mid-cap mutual funds continue to attract a substantial portion of investor capital, raising concerns among financial analysts. In September 2026, these funds collectively received ₹16,873 crore, accounting for 44% of the total equity mutual fund inflows, according to a recent Groww Capview market review.
Investors Chase Returns Amidst Elevated Premiums
The influx into smaller cap funds comes despite these segments trading at considerable valuation premiums compared to large-cap stocks. Groww Capview highlights that investors might be chasing past performance and potentially taking on excessive risk in pursuit of higher returns.
A breakdown of September's inflows reveals small-cap funds attracted ₹9,039 crore, while mid-cap funds secured ₹7,835 crore. In stark contrast, large-cap funds received a mere ₹859 crore, even though equity fund inflows surged by 31% overall to ₹38,307 crore during the month.
This divergence between investor flows and underlying valuations is particularly notable given that small and mid-cap stocks have already outperformed large caps over the past year. This leaves investors vulnerable to a potential valuation correction if corporate earnings do not justify current prices.
Valuation Premiums Remain Elevated
Groww Capview's analysis underscores the persistent expense of small and mid-cap stocks:
- The Nifty Smallcap 250 traded at a forward price-to-earnings (P/E) multiple of 23.6 times in September 2026. This represents a 34% premium to large caps, significantly above its 10-year average discount of 11%.
- The Nifty Midcap 150 traded at 25.8 times forward earnings. This segment maintained a 47% premium to large caps, far exceeding its 10-year average premium of 19%.
Over the year ending September 30, 2026, the Nifty Smallcap 250 rose by 7.2% and the Nifty Midcap 150 gained 4.6%, while the Nifty 50 declined by 7.1%. This relative resilience may explain continued investor interest, but Groww Capview warns that small-cap valuations have corrected far less than large caps from their 2024 peaks.
Historical Precedent and Risk Assessment
Historically, periods of elevated small and mid-cap valuations have been followed by sharp relative declines. After market peaks in 2007, 2010, and 2017, small caps typically lost a median of 30% against large caps over the subsequent two years. While small companies often rebound after large-cap corrections, the report notes that mid and small-cap stocks have already seen a strong rebound since the February 2025 market low, suggesting a different scenario this time.
High valuations inherently reduce the margin for error, leaving less room for disappointment if corporate earnings weaken or market sentiment deteriorates. Investors are advised to evaluate their exposure based on long-term investment horizons, personal risk tolerance, and portfolio concentration, rather than solely on recent fund returns.
Groww Capview Recommends Large-Cap Overweighting
Groww Capview advocates for an overweight position in large-cap stocks, citing their more attractive valuations. For mid and small-cap segments, they recommend a selective approach, favoring actively managed funds over passive strategies.
For new investments, the report suggests building large-cap exposure gradually over three to four tranches across a three-month period, rather than deploying the entire amount at once. The core message remains clear: strong inflows do not always signify attractive valuations, and investors should prioritize portfolio balance over chasing recent performance.
“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 concludes.
The recommendation is not to abandon small and mid-cap funds entirely, but to be more discerning about exposure, using large caps as the foundational element of an equity portfolio.