The mutual funds segment is buying into IPOs (Initial Public Offerings), and small-cap stories. According to Ventura Securities’ ‘Mutual Fund Quarterly Booklet (Sept 2025),’ the industry showed “robust participation in newly-listed companies, with total investments amounting to over Rs 8,752 crores across recent IPOs.” In addition, “a majority of these new entrants fall under the small-cap category, with only one categorised as a mid cap.” Thus, there is an urge among the mutual funds to tap into narratives of long-term wealth creation, by buying stocks of scalable businesses that may become tomorrow’s mid-caps, and market leaders.
Ventura Securities states that while nine mid-caps can possibly become large-caps, there are six small-caps that can turn into mid-caps. This implies that the market capitalisation of these stocks, as also share prices, are likely to go up substantially. This expected shift underscores how mutual fund managers identify potential winners in advance. Obviously, the downside is that only a few mid-caps, and small-caps grow, and the ratio of failures, especially in small-caps, can be as high as 70-80 per cent. Like the venture capitalists, who bet that 1-2 stocks of the 10 start-ups they buy will click, the same story is true of the mid-caps, and small-caps.
The dual tendencies to get into IPOs, and small-caps may be driven by the overall stock market conditions. The market indices faced turbulence in the July-September quarter. The Centura Securities’ report states that while the “Nifty50 fell by 3.6 per cent (during the period) … the BSE Midcap and BSE Small-Cap indices fell by (a higher) 4.1 per cent, and 4.6 per cent, respectively.” The correction follows a period of sharp gains in the previous April-June quarter when the mid- and small-cap indices rose 12.8 per cent, and 17.3 per cent, respectively. The potential upside is higher than the predicted downside, although the volatility is higher than the broad indices.
More importantly, there was a divergence in the attitudes of the foreign and domestic investors. “Foreign Institutional Investors (FIIs) were net sellers to the extent of Rs 76.62 billion,” the study states, even as “Domestic Institutional Investors (DIIs) continued to be net buyers, marking a net inflow of Rs 221.11 billion in the September 25 quarter.” Since, the mutual funds are funded by the local retail investors, they were buyers, as also flush with funds, according to recent data released by AMFI (Association of Mutual Funds in India). In September, 2025, equity mutual funds witnessed an inflow of more than Rs 30,000 crore, which fell the next month, but were still robust at nearly Rs 25,000 crore.
On a slightly-longer horizon, “For the September 25 quarter, equity schemes saw an inflow of Rs 1,06,554 crore as compared to Rs 66,869 crores in the previous quarter,” stated the report. Debt schemes saw outflows of Rs 3,156 crore, which reflected the preference for equities despite the moderate market weakness. Hybrid schemes sustained interest with inflows of Rs 45,570 crore, and SIP (Systematic Investment Plan) investments touched a new record of Rs 29,361 crore in the September quarter, up a tad from Rs 27,269 crore in the June quarter. In October, 2025, small-cap funds drew in nearly Rs 3,500 crore, and the figure for mid-cap ones was Rs 3,800 crore.
Thus, small-caps and mid-caps, despite higher risks, can earn returns that are higher than the broader indices. Most of the stock market inflows are being driven by domestic investors, and mutual funds. The local buyers are more enthused by equity despite the volatility. The moderation in the inflows in equity mutual funds in the recent months stems largely from the market corrections rather than the weakening investor sentiment. Unlike the case of the foreign investors, the net inflows by the local investors are still positive, although the percentage changes are tempered. The equity story in India is still an ongoing one, but punctuated by pauses.
Data suggests that both institutional and retail investors view small-cap and mid-cap segments as the growth engines. SIP flows, domestic participation, and IPO enthusiasm paint a picture of confidence. As the Ventura Securities’ report summarises, mutual funds are strategically “allocating towards smaller, scalable businesses that have the potential to deliver superior returns over time.” Over the next few years, several of the small-cap entrants may graduate into the mid-cap league, and reshape the contours of the corporate landscape. Still, small-cap investing requires patience and discipline. These firms, ranked below the top 250 by market cap, represent businesses that operate in niche or fast-growing sectors.
However, they are more volatile and less liquid. Prices swing sharply due to earnings surprises, market sentiments, and liquidity changes. On the positive side, small-cap stocks deliver outperformance. A key factor is the widening valuation gap between small-caps and large-caps. This occurs when valuations turn expensive, yet liquidity chases equities. Fund managers thus look for undervalued segments or untapped opportunities that are available at the lower end of the market spectrum. Small-caps, with their smaller base, are the logical entry-points, especially since they constitute undiscovered stories. However, this comes with the classic trade-off: higher the risks, higher the potential for rewards and losses. Mutual funds, explains the report, are willing to bet on small-caps due to the existing belief that they can “deliver superior returns over time.”
