Snehasis Mitra, 32, a Kolkata-based independent researcher, started investing a portion of his savings in small-cap funds about three years ago. After delivering stellar returns in recent years, his portfolio has now slipped into the red. Yet, he is determined to sail through the choppy waters.
“Three years ago, I began investing 15% of my total savings into small-cap funds. My goal is to outpace inflation over the long run. Recently, my returns have turned negative. But I’m committed to not touching this money for any short-term needs and to continue my Systematic Investment Plans (SIPs) regardless of market volatility, with the aim of achieving solid returns over time.”
2023 was a great year for mutual funds. Small cap funds as a category gave returns of 24.13 percent, mid-cap funds of 18.96 percent, and large cap and mid cap funds returned 13.09 percent. In fact, some small cap funds delivered a return over 60 percent. 2024 was also a great year for small cap funds with an average return of 30.49%.
But such high returns are not sustainable. Year to date returns of small cap funds as a category -3.59 percent in 2025. Over the last one year, returns are -4.09 percent. This had led to panic selling with many investors exiting small caps.
Further, US President Donald Trump’s August 6 order imposing an additional 25 percent “Russia penalty” on Indian goods in addition to the existing 25 percent tariff has investors jittery about the fallout on the Indian economy.
Mitra offers a crucial lesson for investors in small-cap funds. While these funds have exceptional returns, their volatility requires a disciplined strategy of staying invested to ride out the volatility.
Interpreting Long-Term Returns Amid Market Swings
“When it comes to small-caps, looking at one-year returns can be very misleading because corrections are sharp and frequent. Five-year rolling returns give a truer picture of how these funds behave across cycles,” says Ajay Kumar Yadav, Group CEO & CIO, Wise Finserv, a financial services firm.
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One may see temporary dips, but over five-year periods, the numbers usually settle into strong double digits. “For me, the big message is that downturns are not the time to panic, they’re just part of the journey. Patience and perspective make all the difference,” adds Yadav.
Here is where five-year rolling returns come in. Five-year rolling returns show the annualized return of a fund over every possible five-year period. Five-year rolling returns smoothen out short-term volatility and show the fund’s performance consistency over time. Small-cap funds are inherently more volatile and sensitive to market cycles.
During downturns, their returns can look weak or even negative in the short term and vice-versa. Five-year rolling returns offer a longer-term perspective that can help investors see beyond temporary market dips.
“This measure will help investors better assess if the fund has consistently delivered value and can reassure investors during downturns and encourage a long-term perspective rather than making impulsive decisions to exit,” says Kirthi Jain, Vice President – Equity, Bandhan AMC.
Rolling returns thus help investors to understand how the funds have performed over time. Investors can assess such distribution of rolling returns over the long term to understand the risk-reward associated with the small cap segment of the market or category of funds and accordingly make investing decisions based on their ability to withstand the risk.
“It’s important to mention that many actively managed small cap funds have historically done better than the small cap index but from a relative perspective, the risk in small cap funds tends to be significantly higher than their large cap counterparts,” says Nilesh D Naik, Head of Investment Products, Share.Market (PhonePe Wealth).
How Staying Invested Pays Off
The primary lesson is the critical importance of a long-term horizon. “Case studies show that panic selling during downturns locks in losses, while patience allows the investment thesis to play out, as small caps often rebound strongly,” says Soumya Sarkar, Co-Founder, Wealth Redefine, an AMFI-registered mutual fund Distributor and wealth management company.
Small-cap funds often experience sharp ups and downs. Investors who remain patient and avoid panic selling during downturns often benefit from the recovery and long-term growth phases. “Volatility is normal in small caps. Successful investors focus on their long-term financial goals rather than reacting to short-term market noise or temporary losses,” says Jain.
Trying to exit during a downturn and re-enter at the bottom is very difficult. Case studies show that investors who “time the market” often miss the best recovery days, hurting overall returns.
“Emotions like fear and panic can drive poor decisions. Investors who stick to their plan despite market fears tend to achieve better outcomes,” says Jain.
Tactics to Avoid Emotional Exits
“Use goal-linked investing. Tie small-cap investments to long-term goals. This creates a powerful mental anchor and stops you from reacting to short-term noise,” says Sarkar.
SIPs help you to average costs and stop you from second-guessing the market. Many case studies have highlighted how continuing SIPs during downturns have allowed investors to buy more units at lower prices, lowering their average cost and enhancing long-term returns.
And of course, keep your exposure balanced. “If only 15–20 percent of your equity portfolio is in small-caps, the ups and downs feel less scary, and you can actually use volatility to your advantage,” says Yadav.
Maintaining an emergency fund prevents forced selling during downturns. Automating investments enforces discipline and removes emotional decision-making. Together, these strategies promote patience and long-term wealth creation despite volatility in small-caps.
Aligning Small-Cap Funds with Financial Goals
Investors must first assess their liquidity needs. Small-cap funds are volatile and should be locked in for seven to 10 years. “Needing this money for an emergency or a near-term goal like a down payment is a major red flag. Cashing out during a downturn to meet an expense guarantees significant losses,” says Sarkar.
It’s important to have a pre-determined asset allocation framework when it comes to allocation to different segments of the market. For relatively conservative investors, it would make sense to stay away from small cap investing as they come with significantly higher risk and risk averse investors may not be able to stay invested through the extreme ups and downs in small cap funds.
Investors often get carried away by substantially higher returns of small cap funds compared to large cap funds in certain phases. “However it’s critical to understand that (a) over the long term the returns gap between small cap funds and large cap funds typically tends to reduce and (b) small cap funds tend to go through significantly higher ups and downs compared to large cap funds,” says Naik.
Small-caps are a rollercoaster—fast climbs, sharp drops. They demand patience, but with SIPs and balance, they can deliver strong long-term results.