The Smallcap vs Largecap Power Shift: Who Wins in H2 2025?

As the second half of 2025 begins, the Indian equity market finds itself at a crossroads of two worlds. On one side, the largecaps have done the heavy lifting, powering the Nifty 50 around 1,500 points in six months to hover at a kissing distance of its all-time highs. On the other is the trailing broader market, which houses small and midcaps, failing to play catch-up with the largecap giants.

While the Nifty 50 has climbed nearly 8% year-to-date, the Nifty Midcap 100 has tried hard to match with 4% gains, while the Nifty Smallcap 100 lags far behind with a mere 1.5% upmove.

However, a scratch beneath the surface reveals a different story. While the headline numbers suggest sluggishness in the broader market, smallcaps in particular have made a dramatic recovery after a difficult start to the year.

By 15 April, the Nifty Smallcap 100 had taken a huge blow, down nearly 14% for the year as concerns of overheating and valuation froth across the segment soured sentiment. Midcaps also came under pressure, with the Nifty Midcap 100 slipping around 9% during the same period.

The downturn was driven by risk-off sentiment, partly triggered by heightened global uncertainty, including reciprocal tariffs introduced by the Trump administration and a relentless exodus of foreign institutional investor (FII) flows. Largecaps, by contrast, held relatively steady during this stretch, with the Nifty 50 remaining largely flat.

Yet, by the end of June, smallcaps had made up lost ground. The Nifty Smallcap 100 clawed back into positive territory, recovering from its April lows to finish the first half of the year slightly higher in a sign of optimism making its way back into the broader market.

As H2 begins, the key question for investors is whether this recovery in smallcaps marks the beginning of broader participation or merely a pause in an otherwise cautious trend.

Tailwinds Favouring Smallcaps

A slew of tailwinds, including the Reserve Bank of India’s frontloading of rate cuts, easing inflation, recent liquidity flows, and improving fundamentals are all setting the stage for a strong resurgence of the smallcap hemisphere.

Analysts at Ionic Wealth noted that small and midcaps have outpaced large caps on profit growth across most sectors, making up a factor behind their higher-than-historical valuations while also highlighting where the next leg of earnings momentum lies.

Meanwhile, Ionic Wealth also pointed towards an interesting correlation between strong growth in profit and Ebitda, and the broader equity market performance. Historical data collated by Ionic Wealth charts that in FY21, FY22 and FY24—all years which saw robust profit expansion—coincided with double-digit returns from the Nifty 500, reinforcing the idea that profit growth, rather than revenue momentum, is a bigger driver of equity market rallies.

Another study by Bajaj Finserv Asset Management reveals that even though the small-cap index gained only 4% since FY24, profit after tax grew by 38%, highlighting the segment’s unrealised value.

Moreover, 74% of the top 250 small-cap companies reported double-digit returns on capital employed (ROCE), indicating strong underlying fundamentals, it added.

On that note, analysts at Bajaj Finserv AMC stated that the steep correction in smallcaps during the second half of FY25 created an opportunity to accumulate quality small caps at better valuation. “As of April, most small caps continue to trade below their 52-week highs, making the segment appealing from a valuation standpoint,” the asset management firm said.

VK Vijayakumar, Chief Investment Strategist, Geojit Investments, partly nods to the idea as he believes the action in the mid and smallcap space since mid-April has been in response to the quarterly results.

However, he still holds a slightly cautious view, suggesting investors weigh in valuations when chasing mid and smallcap stocks. “Despite that, quality mid and smallcaps have the potential to outperform,” Vijayakumar added.

Fund Flows Make a Shift

Another major tailwind cheering for smallcaps has been the consistent equity inflows pouring into the segment. While smallcap stocks have underperformed on the bourses in 2025, they continue to attract strong investor interest through mutual funds. According to data from the Association of Mutual Funds in India (AMFI), smallcap equity schemes received inflows of ₹3,214.21 crore in May, outperforming midcap and largecap schemes, which saw inflows of ₹2,808.68 crore and ₹1,250.47 crore respectively.

Even as overall equity mutual fund flows moderated in May, smallcap funds stood out as the preferred category, continuing to command attention despite broader market caution.

Between January and May 2025, smallcap schemes accounted for over 15% of total equity inflows, making them a consistent magnet for investor capital. This trend has held firm even as overall equity mutual fund inflows have slowed for five consecutive months.

What makes this more interesting is the contrast. While smallcap indices have underwhelmed on the screen, investors still chose to bet on the long game, latching on to the growth potential.

Sentiment Is Shifting but Risks Persist

As market chatter grows louder about smallcaps leading the charge in the second half of 2025, not everyone is convinced. While several participants are optimistic about a broader market revival, concerns around frothy valuations and narrative-driven rallies continue to weigh on sentiment.

Kotak Institutional Equities has long maintained a cautious stance on mid and smallcaps. Sanjeev Prasad, Co-Head of Institutional Equities at KIE, remains wary despite recent corrections in the segment. He believes valuations are still frothy, especially in pockets driven more by ‘narrative’ than substance.

“The market is once again in the grips of irrational exuberance, quickly chasing half-baked narratives, with defence stocks being the latest example,” Prasad said. “It’s surprising how frequently the market forgets the fate of such themes. Several have risen and collapsed in just the last 2–3 years.”

This recurring tendency to latch on to momentum stories, according to Prasad, reinforces the need for selective participation, particularly in the smallcap space, where quality remains scarce and volatility high.

A recent study by Bajaj Finserv AMC supports this view. It found that nearly 50% of smallcap companies from 2017 have since dropped into the microcap bucket, a sobering reminder of how quickly hype can turn into underperformance.

Despite these risks, analysts agree that quality smallcaps do exist, but spotting them requires far more rigour today. With global macro uncertainties and selective optimism gripping the market, the message is clear: this is not the time to follow the crowd, but rather to stick to the fundamentals.

As optimism builds around a potential smallcap revival in H2 2025, analysts are pointing investors towards domestically driven sectors as the most promising bets.

With macroeconomic indicators improving, corporate earnings stabilising, and liquidity conditions easing, the backdrop appears increasingly favourable. Add to that steady fund inflows, and the stage may be set for select smallcap names, particularly those aligned with India’s long-term growth story.

Analysts believe these segments are better positioned to weather global uncertainty and benefit from ongoing policy support and private capex recovery.