Naren is a respected industry stalwart, known for his wisdom and expertise in the mutual funds industry. His stark warning has left investors scrambling to re-evaluate their portfolios to limit exposure to these battered segments.
It was time to exit these stocks entirely, he said: “We think it is a clear time to take out lock, stock, and barrel from small and midcap.”
The year 2025 could be the most dangerous since the 2008-10 period, when investors lost a lot of money, particularly in banks, Naren said. But today, most of the risk lies with retail investors, as companies looking for capital raise funds directly from equity investors via IPOs or Qualified Institutional Placements, he said.
Naren said investors are assuming that SIPs will shield them from volatility, while putting their money into small- and mid-caps. But the momentum in these stocks is starting to fade, and they’ve dropped below their daily moving average. He advised investors to consider investing in hybrid schemes or multi-asset funds.
How badly have small- and mid-cap stocks fared?
Small-cap stocks have plummeted 18% over the past two months, and the mid-cap index has fallen 17.61% in the last eight weeks.
The sell-off, which began in December 2024, has gathered pace since Naren’s comments. The BSE Small-cap Index has fallen more than 6%, and the Mid-cap Index by more than 5.3% since February 7 alone. As a consequence, investors holding small and mid-cap stocks have experienced a substantial decrease in portfolio values.
The BSE Midcap and Smallcap Indices were at 39,731 and 45,411 respectively on Friday compared to corresponding figures of 46,675 and 55,750 at the beginning of this year.
The sell-off has also contributed to overall market volatility, affecting investor confidence and leading to increased foreign outflows. Thousands of crores in investor wealth have been wiped out, and there seems to be no end to the turmoil in sight.
Are large-cap stocks safe for investors?
The recent sell-off in large-cap stocks, triggered by foreign institutional investors’ massive selling due to the strengthening dollar, may have created a buying opportunity for investors. The dollar’s dominance will eventually reverse, and foreign investors will return to buying large-cap stocks in India, according to Naren.
Naren advised investors to take advantage of the current market conditions by investing in large-cap-oriented funds or hybrid-oriented funds through SIPs and systematic transfer plans (STPs).
While large-cap stocks are not undervalued at present, they are also not significantly overvalued. The near-term return environment is moderate due to valuations not being extremely cheap. Asset allocation is the best investment strategy, involving lump-sum investments in hybrid categories and systematic investment plans in flexible mandates, such as flexi-cap funds.
How have fund houses been impacted by the small-cap selloff?
Net assets under management (AUM) of small-cap funds fell by Rs 23,665 crore, or 7.19%, to Rs 3.05 lakh crore in January compared to Rs 3.29 lakh crore in December. Mid-cap funds witnessed their assets shrinking by Rs 26,600 crore, or 6.65%, to Rs 3.73 lakh crore in January compared to Rs 3.99 lakh crore in the previous month, according to data from the Association of Mutual Funds in India (AMFI).
Net AUM of equity mutual funds fell by Rs 1.1 lakh crore, or 3.26%, on a month-on-month basis, to Rs 29.46 lakh crore in January 2025, highlighting the vulnerability of mutual fund investments to market volatility.
“XIRR (extended internal rate of return) of my investments in a mid- and small-cap scheme has fallen by 23% in the last couple of months. Experts have advised me to keep investing through SIPs (systematic investment plan) despite the selloff. I’m worried but hopeful of a recovery in line with the past record,” Jacob Cyriac, a software engineer now based in the US, said.
XIRR is a parameter used to calculate the returns on a mutual fund investment. It’s useful for investments with irregular cash flows, such as those made through an SIP.
Will small- and mid-cap stocks recover?
A full recovery will happen, but may take some time, analysts say. Investors are advised to exercise caution, assess the quality of their holdings and consider diversifying their portfolios.
“Do not fall for the fear-mongering 10-day debates,” Radhika Gupta, CEO of Edelweiss Mutual Fund, wrote on social media platform X.
Gupta underlined the need for a balanced approach to both mid- and small-cap stocks. Even a typical flexi-cap fund has about 30% of its investment in this category. The point is to make money, and it is essential to stay invested in SIPs for the long term, ideally 10 years or more, she said.
Is the market still under pressure?
The market, which has fallen about 3% since January 1 this year, is under pressure as foreign investors have pulled out Rs 1,00,000 crore since January 2025, attracted by US bond yields at 4.49%, and a strong dollar.
Also, the 25 per cent tariff imposed on steel and aluminium by President Donald Trump could cut US steel imports by 80%, increasing global surplus risks for India.
Analysts caution that the current volatility could continue until several major uncertainties are resolved. The US Federal Reserve’s policy direction, President Trump’s tariff plans, India-US trade talks, and a domestic valuation reset are all key factors that need to be clarified for market stability to be restored.
However, analysts also point to several potential positives that could boost market sentiment in the coming quarters. A recovery in GDP growth, improved corporate performance, low inflation, and potential rate cuts by the Reserve Bank of India could all contribute to a more buoyant market.
Small-cap stocks have plummeted 18% over the past two months, and the mid-cap index has fallen 17.61% in the last eight weeks. (Freepik photo) 
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