Mutual funds are showing renewed interest in small-caps

Small-cap stocks, which had fallen significantly, have recently experienced a rally. This has led some mutual funds to consider investing in these once-beaten-down stocks. In the last two years, small-cap stocks dropped nearly 24% from their highs before the recent rally helped limit losses to 20%. Whether this trend will continue remains uncertain. Experts note that the previous surge in small-cap stocks was fueled by easy money and a strong appetite for risk. In 2023 and 2024, the BSE Smallcap Index rose by 47% and 28%, respectively. However, small-cap stocks are now in a bear market, having declined 16.6% in 2025 alone. This decrease in valuations may attract funds that have previously hesitated to invest. An investment manager remarked that the recent correction has created better opportunities for long-term investors in small-caps. Many fund managers are shifting focus on companies that show solid earnings growth and reasonable valuations instead of taking high risks. This approach reflects a change from the previous strategies that favored higher returns. Some mutual funds have been adjusting their portfolios. They have exited certain small-cap stocks to make room for more promising ones. These shifts have included sectors like pharmaceuticals, healthcare, and metals. Conversely, one fund manager cautioned that it may be premature to make broad changes, suggesting that recent buying is to acquire existing stocks at lower prices. Data shows that mutual funds invested heavily in the secondary markets during a recent downturn, even as foreign investors sold shares. Reports indicate that major funds have completely exited three small-cap stocks, which reflects a strategy to cut underperformers in a market where cash is tight. For example, Savita Oil Technologies has seen its stock price fall significantly this year and its profits decline steeply, making it less appealing to investors. Similarly, Shyam Metalics, despite delivering solid returns and profit growth, was also let go due to its high valuation compared to past performance. Lastly, Krystal Integrated Services, trading at a discount to its historical valuations, demonstrated mixed earnings results that failed to convince funds to maintain their stake. This shows that even undervalued stocks are not guaranteed to retain mutual fund interest amid market volatility.