How to Win in Small-Cap Mutual Funds (2026 Edition)
The last 12 months have been a “carnage” for small-cap stocks. While the average fund lost about 5% of its value, a few “smart” funds actually made money.
If you want to pick a winner for the next 10 years, you need to look at… pic.twitter.com/32PY94jA1Y
— CA Nitin Kaushik (FCA) | LLB (@Finance_Bareek) February 26, 2026 ” target=”_blank”>small-cap stocks is inherently high risk, given their sharp price volatility and deep sensitivity to economic cycles. These companies are closely tied to domestic demand, credit availability and private capital expenditure (capex). Over the past 12 months, small-cap stocks have faced a severe correction, with the average small-cap mutual fund declining nearly 5% amid valuation resets and broad-based selling pressure. Yet, despite what many investors termed a “carnage,” a select group of actively managed funds not only protected capital but generated positive returns.
According to CA Nitin Kaushik (FCA), long-term wealth creation in small caps now depends less on blind diversification and more on thematic positioning.
“If you want to pick a winner for the next 10 years, you need to look at how they handle AI, Power, and Commodities. Here is the top 5 breakdown,” Kaushik said.
The ‘Double-edged sword’
Traditional IT stocks were among the biggest laggards during the correction, hurting funds that remained overweight on legacy technology names. However, better-performing funds used the downturn strategically.
They selectively accumulated companies leveraging artificial intelligence and digital platforms while avoiding old-economy IT businesses facing structural growth stagnation. The differentiator was not sector allocation alone, but quality, adaptability and future readiness.
Kaushik outlines three key filters for investors:
Funds that did not collapse during the downturn
Exposure to Power and Energy themes
Strong consistency over 5- and 10-year horizons
The standout performers
Bandhan Small Cap Fund emerged as a capital protector, delivering 15.59% over the past year despite broader weakness. Its five-year average return stands at 25.08% annually. The fund trimmed risky tech exposure and increased allocations to Construction and Power companies, steering clear of crowded trades.
Nippon India Small Cap Fund generated 12.16% over one year and an impressive 21.67% average return over 10 years. It maintained strong exposure to Power and Steel, while its IT allocation focused on AI-driven and platform-led businesses.
Invesco India Smallcap Fund rose 16.60% over the past year and delivered 24.23% annualised returns over five years. Its strategy centred on valuation discipline—trimming overheated stocks before the correction and reallocating toward manufacturing and power supply names.
HDFC Small Cap Fund remains a long-term anchor with a 10-year average return of 19.50%, favouring steady banking and services businesses. Quant Small Cap Fund, with a 26.48% five-year return, has taken aggressive energy bets while maintaining minimal exposure to legacy IT.
Kaushik also flagged Bank of India Small Cap Fund as a “hidden gem,” citing its 11.14% one-year return and 21.84% five-year average, supported by strong steel and manufacturing exposure.
The structural reality
Small caps typically face disproportionate pressure during rising interest rate cycles or economic slowdowns, as many depend heavily on borrowing to fund expansion. High leverage, weaker cash flows and promoter pledging can amplify downside risks.
However, earnings have shown resilience. Over the past three years, small-cap earnings witnessed a V-shaped recovery. Even in 2025, with revenue growth moderating to 10–11%, profit growth remained robust at 14–29% due to operational efficiencies. This helped the Nifty Smallcap 250 TRI deliver a 21.2% CAGR over three years and 19.6% over five years as of February 23, 2026, though it remains about 17.18% below its September 2024 peak.
Investor appetite remains intact. In 2025, 128 equity funds were launched, including three small-cap funds that raised ₹2,643 crore through NFOs. Total inflows into small-cap funds hit a record ₹52,321 crore despite volatility.
The bottom line
The lesson from the shakeout is clear: corrections are not signals to exit blindly. Instead, focus on funds that demonstrated resilience, aligned with Power, Energy and AI themes, and maintained durable long-term track records. In small caps, strategy, valuation discipline and sector selection determine survival—and outperformance.
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.