Softer valuations making room for phased entry

The BSE Smallcap index has slipped to an eight-month low, bringing the high-risk, high-reward nature of small-cap investing back into focus.

- SANJEEV SINHA.

Small-cap funds have come under pressure amid geopolitical uncertainty, tariff-related concerns, softer earnings growth, and weaker risk appetite.Reasons for correction

Small caps have struggled primarily because earnings have failed to justify the expectations built into prices. “Based on Q1 and Q2FY26 results and current estimates, profit growth for the small-cap universe in calendar year 2025 is likely to be around 11-12 per cent - modest for a segment that was trading near 40 times earnings,” says Ankit Patel, cofounder and partner, Arunasset Investment Services.

A key drag has been weak nominal GDP growth, estimated at 9-10 per cent due to low inflation. “Since tax collections, government spending and corporate profits move with nominal GDP, subdued inflation has capped profit growth,” adds Patel.

Smaller companies, in particular, have limited pricing power, which has weighed on margins. Geopolitical uncertainty has further dampened investor risk appetite.

Potential turnaround triggers

Two levers could shift sentiment: Reflation and liquidity. In 2025, the Reserve Bank of India (RBI) cut the repo rate from 6.50 per cent to 5.25 per cent between Feb-

2025: A testing year