Mid-cap and small-cap mutual funds have outperformed: Why should investors favour large-caps at this stage?

Mutual fund investors often spread their equity allocation across large-, mid-, and small-cap funds to balance growth and risk. However, recent mutual fund flows, with stronger inflows into mid- and small-cap categories and outflows from large-cap funds, also reflect changing investor preferences.

In the last one year, large-cap funds delivered a category-average return of -4.76%, compared with 2.87% for mid-cap funds and 8.02% for small-cap funds.

An October 2026 Netra report from DSP Mutual Fund points to a sharp divergence between large caps and the mid- and small-cap segments, raising an important question about why investors should review their equity fund allocations at this stage.

Why should you prefer large-cap funds at this stage?

DSP Mutual Fund says the market is unusually polarised, with small and mid-caps trading at elevated valuations while several large-cap segments have undergone a significant correction. Over the past year, small and mid-caps have outperformed the Sensex by 21.5% and 14.1%, respectively.

The report noted that “Large caps have corrected enough for valuations to be near fair/cheap zones. SMIDs (small-cap and mid-caps) have seen less valuation compression and still need stronger earnings delivery to justify broad exposure. Large-caps may offer more opportunities at this time.”

For mutual fund investors, this means large-cap funds, which invest predominantly in established companies, could currently offer a relatively better margin of safety than mid- and small-caps. The report adds, “Barring the COVID decline, large caps haven’t been this attractive in over a decade.”

The report also noted that “during each downcycle, SMIDs lose almost all the alpha generated during the upcycle.” Currently, SMIDs have a large alpha over large-caps, suggesting that investors may be better served by increasing their focus on large-cap funds.

How wide is the valuation gap between large and mid or small caps?

The report’s valuation data also offers an important comparison for mutual fund investors. The Nifty 100, Nifty Midcap 150 and Nifty Smallcap 250 are key benchmark indices for assessing the performance of large-, mid- and small-cap funds, respectively.

The Nifty 100’s trailing P/E was 19.3 times at the end of September 2026, against a five-year median of 22.0 times, putting it about 12% below the five-year median.

By comparison, the Nifty Midcap 150 was trading at 27.6 times earnings, while the Nifty Smallcap 250 was at 33 times earnings. DSP also says, “SMIDs now need extraordinary fundamentals to sustain extraordinary relative returns.”

For mutual fund investors, the implication is that large-cap funds investing in these stocks may currently have more room for valuation normalisation and can offer better returns.

What should mutual fund investors do with their existing allocation?

DSP argues that investors should focus on “margin of safety rather than relying on recent outperformance”. The report adds that “large caps may offer more opportunities at this time”.

This does not necessarily mean that investors should abruptly exit mid- or small-cap funds. Those with long investment horizons can continue their SIPs, but should review whether their equity-fund portfolio has become excessively tilted towards categories that have already delivered strong relative returns.

For mid- and small-cap mutual funds, DSP recommends that investors “follow the SIP route”. This approach can help investors avoid basing their allocation decisions solely on recent returns and volatility.