In recent months, Indian retail investors have started to reconsider their investments in mid- and small-cap stocks, which have been popular due to their lower trading prices compared to larger counterparts. This shift is largely attributed to heightened volatility in the domestic market, influenced by both local challenges and global economic factors. As a result, many investors are pulling back from these segments, reflecting a broader trend of caution in investor sentiment.

Market Volatility and Investor Sentiment

The ongoing sell-off in local equities has severely impacted mid- and small-cap stocks, leading to a notable decline in trading volumes and even a decrease in new demat account openings. The recent turbulence has made investors wary, as evidenced by data indicating a drop in mutual fund investments, which had previously seen a surge in retail participation.

• February 2023 saw a significant decline in equity mutual fund inflows for the second consecutive month.
• According to the Association of Mutual Funds in India (AMFI), inflows into equity funds dropped from ₹39,688 crore in January to ₹29,303 crore in February.

Shifting Investment Strategies

In the face of declining market conditions, many investors are re-evaluating their strategies. The Systematic Investment Plan (SIP) inflows also witnessed a downturn, falling to a three-month low of ₹25,999 crore in February, down from ₹26,400 crore in January. The Assets Under Management (AUM) for SIPs decreased from ₹13.19 lakh crore to ₹12.38 lakh crore during the same period.

Mid- and Small-Cap Funds Struggle

The latest figures reveal a stark contrast in inflows between segments:

• Mid-cap funds: ₹3,406 crore in February, down from ₹5,147 crore in January.
• Small-cap funds: ₹3,722 crore in February, compared to ₹5,720 crore in January.
• Large-cap funds: Although experiencing a dip, they remained relatively stable with ₹2,866 crore in February, a slight decrease from ₹3,063 crore in January.

Analysts Weigh In on Market Trends

Market experts are raising concerns about the inflated valuations of mid- and small-cap stocks. They suggest that even after recent corrections, these valuations still appear stretched. Notably, during periods of market instability, large-cap stocks tend to offer more stability and align better with fundamental values.

"Large-cap stocks currently present attractive valuations and are generally more stable during volatile market conditions. Their established market presence and lower risk profile make them a preferable option for those aiming for long-term investment security," noted Nehal Meshram, a Senior Analyst at Morningstar Investment Research India.

The Growth of Small-Cap and Mid-Cap Investments

Despite the current market fluctuations, the years leading up to 2023 saw a significant influx of investment into small- and mid-cap stocks. For instance, the AUM of small-cap funds skyrocketed to ₹3.30 lakh crore by the end of 2024, a sixfold increase since January 2020. Mid-cap funds also experienced a substantial growth, with AUM reaching ₹4 lakh crore, quadrupling over the same period.

In summary, while retail investors once flocked to mid- and small-cap stocks for higher returns, recent market shifts have prompted a cautious pivot towards more stable investment options. As the landscape continues to evolve, it remains crucial for investors to stay informed and adaptable in their strategies.