SMID Cap Mutual Funds Deliver Superior Long-Term Returns

Market Outlook and Investment Strategies

For investors seeking long-term wealth creation, a shift away from large caps may be necessary. According to Anupam Tiwari, Head of Equities at Groww MF, the preference remains for small caps first, followed by mid caps, and then large caps.

The market has been grappling with two major issues: the earnings slowdown that started around Q1 FY25 and the increase in oil prices due to geopolitical tensions. However, the earnings outlook is improving, with exports recovering, consumer sentiment improving after tax relief measures, and government capex picking up after election-related disruptions.

Key Risks and Opportunities

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Oil prices are the bigger concern, as wars primarily impact energy markets. Even if geopolitical tensions persist, oil prices can decline if supply routes normalize. The key risk is disruption through critical routes such as the Strait of Hormuz. If those disruptions ease and supplies normalize, oil prices should decline.

Higher oil prices will inevitably act as a drag on growth. When oil prices rise, a larger share of national income leaves the country instead of circulating within the domestic economy. If fuel prices are not allowed to adjust fully, the burden ultimately shifts to government finances through subsidies or reduced capital expenditure. Either outcome is negative for economic growth.

Attractive Sectors

The areas that appear most attractive are premium consumption, financials, manufacturing exports, and infrastructure. Within premium consumption, there are opportunities in autos, lifestyle-oriented businesses, discretionary spending categories, and hospitals.

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Underweight Sectors

The portfolio remains relatively underweight on pharma and oil & gas. This is not because these sectors are fundamentally unattractive, but because there are better opportunities available elsewhere. The focus remains on business quality, growth potential, and valuations. In general, commoditized businesses do not fit particularly well within this framework.

Investment Strategies

The portfolios remain largely invested, with multi-cap portfolios holding around 8-9% cash and small-cap portfolios holding approximately 13-14% cash. The somewhat higher cash level in small caps is largely a consequence of inflows rather than a negative market view.

Long-term Wealth Creation

Over a five-to-ten-year period, mid-cap and small-cap companies are believed to offer superior wealth-creation opportunities. Many large-cap companies have already reached substantial scale and therefore face more limited growth opportunities, greater competitive intensity, and the possibility of valuation de-rating.

Recommended Fund Categories

Investors with an investment horizon of eight to ten years or longer can consider small-cap funds because they offer the highest long-term wealth-creation potential, although they also come with the highest volatility. Investors with a five-to-seven-year horizon can consider mid-cap or multi-cap funds, while those with a three-to-five-year horizon may be more comfortable with flexi-cap funds. For shorter horizons, hybrid funds are generally more suitable.

When comparing multi-cap and flexi-cap funds, the preference is often for multi-cap funds over the long term. The reason is that multi-cap funds are required to maintain meaningful allocations to large caps, mid caps, and small caps, forcing the fund manager to systematically allocate capital across market-cap segments and participate in opportunities wherever they exist.