Reasonable valuations, earnings revival to drive turnaround

Smallcap funds delivered a return of -5.5 per cent in 2025, marking a phase of underperformance after two years of strong gains in 2023 (43.4 per cent) and 2024 (26.3 per cent).

- HIMALI PATEL

Investors with a long-term horizon should not throw in the towel at this stage.

“Periods of underperformance often create attractive entry points. Leadership in Indian equities has historically emerged from such phases when backed by domestic growth drivers,” says Ajay Khandelwal, fund manager, Motilal Oswal Asset Management Company.

Why smallcaps underperformed

In 2024, the central government and the Reserve Bank of India (RBI) implemented a series of fiscal and monetary tightening measures to rein in inflation and stabilise the rupee against the US dollar. While these steps achieved their objective, their impact on growth emerged with a lag. Consumer demand weakened and corporate earnings growth slowed through 2025. The slowdown hurt the smallcap universe the most.

“With valuations high and earnings declining, stocks had to correct to adjust for the dip in earnings,” says Dinshaw Irani, managing director and chief executive officer, Helios India.

“Earnings failed to meet expectations, particularly among capital goods, consumption-linked and export-oriented smaller companies,” says Arihant Bardia, chief investment officer and founder, Valtrust.