Top 5 small-cap funds can take 28 days longer than mid-caps to sell half of their portfolios: Experts discuss risks

Mutual fund investors often look at returns, risk, and fund size, but liquidity can become equally important during a market downturn. SEBI’s FY26 annual report shows that small-cap funds could take longer than mid-cap funds to liquidate half of their portfolios.

During March 2026, the top 10 small-cap schemes by assets under management (AUM) required an average of 38 days to liquidate 50% of their portfolios, compared with 17 days for the top 10 mid-cap schemes.

Among the top five schemes, the average liquidation time was 51 days for small-cap funds, compared with 23 days for mid-cap funds.

Here’s what experts say about the liquidity risks in mid- and small-cap funds.

Why are small-cap funds more vulnerable?

“Small-cap funds are mandated to invest at least 65% of their underlying portfolio in the small-cap segment, where market depth and trading volumes are relatively lower,” said Hrishikesh Palve, Director, Anand Rathi Wealth. This can make it harder to buy or sell large quantities without affecting prices, particularly during volatile markets or heavy redemptions.

Nilesh D. Naik, Head of Mutual Funds, PhonePe, observed that “portfolio liquidity depends on three factors: fund size, stock-level concentration and the trading liquidity of underlying stocks”. He noted that the mid-cap segment remains relatively liquid, while investors should exercise greater caution with large-AUM small-cap funds.

Naik added that the mid-cap segment has benefited from new listings, with the 250th-largest stock having a market capitalisation of more than ₹35,000 crore and the 101st-largest exceeding ₹1 lakh crore.

However, lower liquidity in small-caps can become a problem when a fund or segment underperforms sharply, and redemptions rise, potentially forcing managers to sell stocks at lower prices and increasing impact costs.

Does a high AUM make a fund risky?

Not necessarily. “Large AUM can reflect a strong track record, investor confidence and an established investment process,” said Aditya Agarwal, Co-founder, Wealthy.in.

However, scale can become a constraint when a fund needs to sell substantial positions in stressed markets. Agarwal added that “investors should look at portfolio concentration, exposure to relatively illiquid stocks, cash levels, turnover, portfolio overlap and the fund’s AMFI stress-test results”.

Rohit Aggarwal, Founder and CIO, RO Funds Management, pointed out, “Larger funds may find it harder to generate meaningful alpha or move between positions.” However, he stressed that a small investor in a very large fund need not necessarily worry about being unable to redeem.

Apurv Gupta, Co-founder and CEO, Otto Money, suggested normalising liquidity by AUM to identify funds that are unusually deep in illiquid stocks. Such funds, he said, could face higher illiquidity-induced NAV losses.

What should investors watch in monthly AMFI stress tests?

According to Palve, investors should view AMFI’s monthly stress-test data as a monitoring and transparency tool rather than an investment decision by itself.

He advised looking for consistent trends over time, while recognising that liquidity can deteriorate during periods of heightened volatility and improve as market sentiment recovers.

Gupta noted that “investors should watch whether liquidation time is consistently rising, which could indicate that a fund is becoming more exposed to illiquid stocks relative to its size”.

Agarwal noted that stress tests are hypothetical scenarios, not forecasts of actual redemption timelines. “Investors should therefore use the data alongside portfolio concentration, stock-level liquidity, cash holdings and historical portfolio changes,” he opined.

What if a fund has a longer liquidation period than its peers?

Palve explained that “investors should treat a consistently longer liquidation period as a reason for further evaluation rather than an immediate decision to redeem. A longer liquidation period generally occurs when the fund has relatively higher exposure to less liquid stocks, a larger asset base, or a more concentrated portfolio.”

“Limited liquidity is a risk that needs to be evaluated in the proper context,” said Rohit Aggarwal. During widespread redemptions, investors may be able to redeem their units, but the fund’s selling can create impact costs and price declines.

He also pointed out that investors who remain invested could be left with less-liquid holdings if the fund is unable to sell them proportionately as others exit.

Gupta said, “Because of the T+2 redemption guarantee, the fund would be forced to liquidate stocks at a much lower price. This would hurt not just the exiting investors, but also those who stay.”