Small cap investing is rarely a smooth ride. Sharp rallies are often followed by equally sharp corrections, creating both opportunities and challenges for investors.
Over the past few months, volatility in the small cap space has once again come into focus as elevated valuations, persistent geopolitical uncertainty, and a broader risk-off sentiment have triggered meaningful corrections across several stocks.
However, periods of correction can offer a chance to reassess long-term opportunities within the segment. In such phases, SIPs may offer investors a more measured way to build exposure to small caps by spreading investments over time instead of relying on lump-sum market timing decisions.
Let’s look at why now may be an opportune time to invest in small caps and how the Bajaj Finserv Small Cap Fund, with its 3-in-1 strategy combining quality, growth, and value, can offer investors a way to tap into this segment.
Table of Contents
Why small caps now
Despite the volatility, the underlying picture within the small cap space appears to be evolving. A combination of stronger fundamentals, improving earnings outlook, valuation corrections, and long-term growth potential is shaping the current investment case for the segment.
1. Structural improvement in small cap businesses
In recent years, the financial health of the small cap segment has improved. The cumulative capex among companies in the segment increased from nearly ₹2.2 trillion during FY19–22 to approximately ₹3.4 trillion during FY23–26.
At the same time, balance sheets appear to have strengthened. Net debt-to-equity ratios declined from 0.52x in FY19 to near 0.09x in FY26, while return on equity (ROE) improved from 9% to 12% over the same period. This combination of lower leverage, healthier cash flows, and improving profitability may indicate a more mature small cap ecosystem compared to earlier cycles.
2. Improving earnings momentum
Expectations of potential future growth are another reason why small caps merit attention. Historical trends show that small cap earnings tend to recover sharply after periods of stagnation or slowdown.
For instance, the earnings per share (EPS) of the Nifty Smallcap 100 Index grew by 48% CAGR between FY21 and FY23 following a weak phase. Current estimates indicate a projected EPS CAGR of nearly 20% between FY26 and FY28.
While estimates are subject to change and future growth is not guaranteed, improving earnings visibility often plays an important role in shaping long-term market sentiment.
3. Valuation reset after corrections
After the recent correction, nearly 50% of small cap stocks are currently trading below their 10-year average valuation levels — one of the highest such readings in this period. This means that at present, the universe of opportunities to buy stocks at reasonable valuations is largest in small caps. In comparison, 24% large caps and 36% mid caps are trading at discounts to their 10-year averages.
4. Historical rebound potential
Small caps have historically experienced deeper drawdowns during market stress, but they have also shown strong recovery potential during upcycles.
Across several market cycles since 2004, small caps have generally outperformed the Nifty 50 during recovery phases. However, this higher return potential has historically come with significantly higher volatility.
For instance, during the COVID-19 market correction between January 2020 and March 2020, the Nifty Smallcap index declined by 45%, compared to a 38% decline in the Nifty 50. However, between March 2020 and February 2021, the small cap index rebounded by 136%, outperforming the Nifty 50 rebound of 101%.
Past performance may or may not be sustained in future.
5. Increasing institutional participation
Another notable trend is the gradual increase in domestic institutional investor (DII) ownership in small caps.
DII ownership in the segment increased from 7.6% in December 2016 to 9.2% in December 2023, 10% in December 2024 and 10.7% in December 2025. Foreign Institutional Investor (FII) participation has stayed relatively stable, going from 7% in December 2016 to 8.8% in December 2025.
Source for all data above: Avendus Spark Research, Bloomberg; Data as on April 30, 2026. | Past performance may or may not be sustained in future.
Why SIPs matter in small cap investing
Despite the improving backdrop, small caps remain inherently volatile. Sharp corrections, liquidity fluctuations, and sentiment-driven swings are common characteristics of the segment. This makes timing investments particularly difficult.
A Systematic Investment Plan (SIP) may help investors navigate this uncertainty by allowing investments at regular intervals instead of relying on timing decisions. Through rupee cost averaging, SIPs enable investors to accumulate more units during market declines and fewer units during rising markets, which may average out purchase costs over time.
Historical data offers useful perspective on this trend. Longer holding periods have generally improved return consistency in the small cap segment. An SIP rolling return analysis of BSE Smallcap 250 TRI showed that while shorter investment periods such as three and five years witnessed both sharp gains and steep declines, longer holding periods of 12 and 15 years had no instances of negative returns. At the same time, return potential over these longer horizons remained in double digits, highlighting the importance of investment discipline and long-term participation in volatile asset classes.
| SIP ROLLING RETURNS OF BSE SMALLCAP 250 TRI | ||||||
| Metric | 3-year returns | 5-year returns | 8-year returns | 10-year returns | 12-year returns | 15-year returns |
| Minimum | -44% | -16.3% | -4.4% | -2.4% | 0.2% | 6.1% |
| Maximum | 44.2% | 37.8% | 25.5% | 22.2% | 20.9% | 17.8% |
| Average | 13.6% | 13.4% | 12.9% | 12.9% | 12.8% | 13.6% |
SIPs can also help investors avoid emotionally driven decisions during periods of market stress. Instead of attempting to predict short-term bottoms or tops, investors can continue investing systematically across market cycles.
Source: Avendus Spark Research, Bloomberg; Data as on April 30, 2026 | Past performance may or may not be sustained in future. | For SIP returns, monthly investment of equal amounts invested on the 1st day of every month has been considered.
Bajaj Finserv Small Cap Fund: A quality-growth-value approach
While the case for investing in small caps is compelling, not all small cap companies respond equally to market recoveries. Some businesses emerge stronger due to robust fundamentals, while others continue to struggle despite broader market improvement.
This makes factors such as governance standards, balance sheet quality, earnings visibility, competitive positioning, and scalability particularly important in small cap investing. A disciplined bottom-up approach focused on quality, growth potential, and reasonable valuations may therefore become especially relevant in this segment. These principles underpin the Bajaj Finserv Small Cap Fund, which follows a 3-in-1 approach focused on quality, growth, and value. The bottom-up stock selection approach emphasises businesses with strong fundamentals, scalable growth opportunities, governance standards, and potential valuation comfort.
The scheme is also a true-to-label small cap fund, with approximately 85.89% invested in small cap stocks as of April 2026. To ensure diversification, the portfolio is spread across 79 stocks, with no single stock accounting for more than 3.37% of the portfolio.
On the performance front, the fund has delivered 0.68% returns (direct plan) since its inception on July 18, 2025, compared to -6.52% by its benchmark, BSE SmallCap 250 TRI. This translates to an alpha of approximately 7.20%, emphasising the fund’s ability to participate in market growth while offering relative resilience during periods of volatility.
Source: MFI explorer, Internal analysis; Data as on 30th April 2026 | Returns <1 Yr are absolute returns | Past performance may or may not be sustained in future.
Conclusion
While geopolitical developments and broader market uncertainty may continue to influence investor sentiment in the near term, volatility has historically been accompanied by periods of opportunity for long-term investors. Following both price and time corrections, valuations across sections of the small cap universe have moved closer to historical averages, with roughly half the small cap universe now trading below its long-term valuation levels.
In this environment, staggered investment approaches such as SIPs may help investors participate more systematically through market cycles instead of relying on short-term timing decisions. Equally essential is robust risk management and prudent stock selection, both of which are the backbone of the Bajaj Finserv Small Cap Fund. To learn more about the fund and for statutory information, visit the scheme page.
| Value of Investment of Rs. 10,000 | |||||||
| Scheme | Period | Fund Returns (%) | Benchmark Returns (%) | Additional Benchmark Returns (%) | Fund Value (₹) | Benchmark Value (₹) | Additional Benchmark Value (₹) |
| Bajaj Finserv Small Cap Fund – Regular Plan – Growth | Last 6 Months | 1.22% | -7.06% | -13.16% | 10,061 | 9,650 | 9,347 |
| Bajaj Finserv Small Cap Fund – Direct Plan – Growth | Last 6 Months | 2.74% | -7.06% | -13.16% | 10,136 | 9,650 | 9,347 |
Returns as on 30th April, 2026. Past performance may or may not be sustained in future.
Different Plans i.e. Regular Plan and Direct Plan under the scheme have different expense structure. Benchmark: BSE 250 SmallCap TRI Additional Benchmark: Nifty 50 TRI. Inception Date: 18th July 2025
Period for which scheme’s performance has been provided is computed basis last day of the previous month preceding the date of this material. Simple annualized returns have been provided as per the extant guidelines since the scheme has completed 6 months but not 1 year. However, such returns may not be representative.
Absolute returns for the 6-month period of Bajaj Finserv Small Cap Fund – Regular Plan is 0.61%; Bajaj Finserv Small Cap Fund – Direct Plan is 1.36%.
Face Value per unit: Rs. 10
Please visit https://www.bajajamc.com/downloads?factsheet and download the latest factsheet or click here to access the Performance of other Schemes managed by Fund Manager/s of this Scheme.
