In investing, widely accepted assumptions are often treated as established truths. One common perception is that consistently outperform large-cap funds over the long run. And hence, nvestors with a high-risk appetite should have higher allocation to small cap funds to enhance their portfolio performance.
To find out, PhonePe recently published a study Crisp Mutual Fund Scorecard that analysing 20 years of historical data on the relative performance of the small cap versus the large cap market segments.
For this analysis, the study used the Nifty Small Cap 250 TR Index and the Nifty 100 TR Index to represent the small cap and large cap segments, respectively.
Here are the key findings from the analysis
- Small caps have indeed outperformed over the long term, but the magnitude of this outperformance seems too small to justify the additional risk.
- The annualized return of the Nifty Small Cap 250 Index over the past 20 years was 12.54% versus 11.72% for the Nifty 100 TR Index, resulting in an outperformance of just 0.82%.
- In contrast, the difference in risk is substantial: the annualized volatility for the Nifty Small Cap 250 TRI is 28.81% compared to 21.06% for the Nifty 100 TRI. Moreover, the maximum drawdown is significantly higher than that of the large cap index.
| Returns | Volatility | Maximum drawdown | |
|---|---|---|---|
| Small Cap | 12.54% | 28.81% | -75.56% |
| Large Cap | 11.72% | 21.06% | -61.08% |
- Over shorter time frames, the small cap outperformance vs large cap seems to vary significantly.
- While the difference in long-term returns seems relatively low, over shorter time frames, the small cap index has shown significant variation in its outperformance.
Rolling outperformance of Small Cap over Large Cap across different periods
| Rolling period | Average | Minimum | Maximum |
|---|---|---|---|
| 3 yr | 1.94% | -17.16% | 20.52% |
| 5 yr | 1.31% | -9.12% | 15.29% |
| 10 yr | 1.14% | -4.26% | 6.43% |
(Source: CRISP MF Scorecard March 2026, ICRA MFI360 Explorer Note: Past performance is not an indication of future results. Data as on 30th April 2026. Data is calculated based on rolling performance calculated at each month end over the past 20-years. Data for Small Cap and Large Cap is considered for Nifty Small Cap 250 TRI and Nifty 100 TRI respectively.)
- For example, the minimum and maximum annualized outperformance of Nifty Small Cap 250 TR Index over a 3-year period has been -17.16% and +20.52% respectively.
- This reflects, small caps outperform in a bull market and underperform in a bear market.
Here’s what investors should follow:
- First, small cap funds are not meant for risk-averse or cautious investors, as they tend to be significantly more volatile than large cap funds or the broader market.
- Aggressive investors with a higher risk appetite may consider allocating to small cap funds. Contrary to popular belief, a buy-and-hold strategy in small-cap funds may not be the most effective approach, as the potential excess returns often fall short of justifying the elevated risk.
- Given the strong cyclicality in the performance of small cap funds, a smarter strategy to boost portfolio performance may be to use them tactically based on their relative valuation: investing when they significantly underperform large cap funds and exiting when they show strong outperformance.
- Although small-cap funds have outperformed large-cap funds over the past three years, the gap has narrowed significantly after the market correction seen over the last two years. Valuations have also become more reasonable, making small-cap funds look relatively attractive again. This could potentially offer an interesting opportunity to invest in small cap funds over the next 12-18 months.