3 Best Small Cap Funds for 2025 - Top Performing Small Cap Mutual Funds in India

Small Cap Funds have the potential to create significant wealth for investors as small-sized companies are usually in their growth stage. These companies have the potential to become market leaders of tomorrow. Small Cap Funds also comprise innovative or niche businesses with a hidden growth potential and a scope to increase market share, giving them the room for a higher upside.

In this article, find out the 3 best Small Cap Mutual Funds for 2025 based on 3-year rolling returns. Before we reveal the list, let us get to know about the category in detail.

What are Small Cap Mutual Funds?

Small Cap Funds are equity-oriented mutual funds mandated to invest at least 65% of their assets in equity and equity-related instruments of small-cap companies. SEBI defines small-cap stocks as companies ranking beyond 250 in terms of full market capitalisation. Some of the popular small-cap names include Multi Commodity Exchange of India, Brigade Enterprise, Timken India, Krishna Institute of Medical Sciences, and Crompton Greaves Consumer Electricals.

​​Small Cap Mutual Funds are high risk - high return equity mutual funds. These funds offer investors an opportunity to benefit from the high growth potential of lesser-known gems of the equity market. This category of equity mutual fund can potentially generate significant alpha and even outperform most other sub-categories of equity-oriented mutual funds over the long term.

What is the outlook for Small Cap Funds in 2025?

Over the past few years, small-cap stocks have outperformed and exceeded all expectations. The Nifty Smallcap 250 index has recorded gains of about 26% in the current year, outpacing its mid-cap and large-cap peers. The index is currently near its all-time high levels, despite intense volatility seen from October 2024 onwards.

However, amid the stellar rise in the prices of small-cap stocks, the valuations have soared, and thus the margin of safety appears to have narrowed.

The S&P BSE Smallcap to Sensex ratio, which is a key determinant of valuations in the small-cap segment, currently stands at a peak of 0.7, indicating a high premium and low margin of safety. It is worth noting that the ratio was at around 0.6 level just before the mid and small-cap crash of 2018-19.

That said, despite soaring prices, pockets of value may still exist in some fundamentally sound stocks in the small-cap segment. Such stocks may still have room for further growth and the potential to scale fresh peaks.

However, investors need to be cautious when investing in Small Cap Funds by avoiding short term view on the segment. The equity markets are known to be cyclical -- peaks are followed by downfalls, and vice versa. If the tables turn large caps could potentially outpace small caps in 2025. Thus, it will not be a surprise if a severe correction precedes the new highs.

Who should consider investing in Small Cap Mutual Funds?

Small Cap Funds are suitable for investors looking to uncover the potential of multi-baggers of tomorrow while they are still relatively undiscovered and nascent. However, remember that Small Cap Funds are placed on the higher end of the risk-return spectrum, just a notch below sector and thematic funds. So, small-cap funds are a very high-risk-high-return investment proposition because the stocks of such companies are highly volatile. Therefore, only those individuals who have a very high risk appetite to handle sharp market volatility and an investment horizon of at least 7-10 years can consider investing in Small Cap Funds.

Ideally, Small Cap Funds should only form part of the 'Satellite' portfolio of your equity mutual fund portfolio. Consider limiting Small Cap Fund exposure to 15-20% of the equity mutual fund portfolio.

How are Small Cap Mutual Funds taxed?

Small Cap Funds follow equity taxation. If you sell your Small Cap Mutual Funds units within 12 months, the gains will be subject to short-term capital gains (STCG) tax of 20% compared to 15% earlier.

On the other hand, if you sell your Small Cap Mutual Funds units after completing one year, the gains will be subject to long-term capital gains (LTCG) tax of 12.5% compared to 10% earlier, but only if the gains exceed Rs 1.25 Lakh in a financial year.

Which are the best Small Cap Funds for 2025?

Best Small Cap Fund for 2025 #1: Quant Small Cap Fund

Incepted in October 1996, Quant Small Cap Fund is a momentum-driven scheme in the Small Cap Mutual Fund category that follows aggressive investment strategies. The fund was originally launched as a debt-oriented fund but was recategorised as a Small Cap Fund in 2018.

Quant Small Cap Fund follows an active investment approach whereby it constantly hunts for attractive opportunities, which makes it sector and benchmark agnostic. The fund has performed remarkably well under its current mandate particularly since 2020, which helped it handsomely reward its investors. The fund has now found a place among top-performing schemes, boasting superior returns across time frames.

In the last 3 years, Quant Small Cap Fund has recorded growth at a CAGR of 36.3% on a rolling return basis, higher than the growth of 27.6% in the benchmark Nifty Smallcap 250 - TRI index.

Large-cap names such as Reliance Industries and JIO Financial Services currently form the fund's top allocation followed by small-cap names such as Aegis Logistics, Aditya Birla Fashion and Retail, HFCL, Bikaji Foods International, and Poly Medicure. Unlike many of its peers, Quant Small CapFund does not hesitate holding unconventional bets. Sectorwise, the fund's holding is currently inclined towards Pharma & Healthcare, Banking & Finance, and Petroleum that collectively form around 40% of its assets.

Quant Small Cap Fund is quick in its approach to shift allocation between market caps and sectors depending on the market conditions which gives it the opportunity to identify high alpha bets.

With significant exposure to stocks in the small-cap and mid-cap segments coupled with the active investment approach followed by the scheme, the volatility registered is higher than the benchmark and many of its peers. Nonetheless, the remarkable returns generated by the fund have helped it score high on risk-reward parameters.

Best Small Cap Fund for 2025 #2: Nippon India Small Cap Fund

Having a corpus of Rs 61,646 crore, Nippon India Small Cap Fund is currently the largest scheme in the Small Cap Fund category. Since its inception in September 2010, Nippon India Small Cap Fund has done well across market phases and built an impressive track record of superior performance.

The fund uses diversification as a risk-mitigation technique and holds a large portfolio of over 150 stocks spread across sectors. Nippon India Small Cap Fund aims to identify small-sized companies with high-growth potential that are available at relatively attractive valuations. The fund's focus on quality stocks and holding on to them with a long-term view has helped it outperform the benchmark and its peers.

In the last 3 years, Nippon India Small Cap Fund has recorded growth at a CAGR of 34.1% on a rolling return basis, higher than the growth of 27.6% in the benchmark Nifty Smallcap 250 - TRI index.

Nippon India Small Cap Fund's top holdings comprise a mix of large-cap, mid-cap, and small-cap stocks such as HDFC Bank, Multi Commodity Exchange of India, Kirloskar Brothers, Apar Industries, and Tube Investments of India. It has restricted allocation in each stock to under 2%. The fund is bullish on Engineering stocks, and also maintains exposure to Infotech, Auto Ancillaries, Pharma & Healthcare, and Chemicals.

Nippon India Small Cap Fund has performed consistently well regardless of the market conditions and established a credible long-term track record. Its focus on investing in a wide range of stocks available at a reasonable margin of safety has helped it minimise the downside risk during bearish market phases. Meanwhile, the focus on fundamentally sound stocks having high potential stocks and holding them with a long-term view has enabled it to do well during upside markets.

Best Small Cap Fund for 2025 #3: HSBC Small Cap Fund

The erstwhile L&T Emerging Businesses Fund was merged with HSBC Small Cap Equity Fund in October 2022 after HSBC AMC acquired L&T AMC, and the surviving scheme was renamed as HSBC Small Cap Fund. Notably, the formerly known L&T Emerging Businesses Fund had gained popularity due to its superior run between 2015 and 2017, resulting in a significant rise in its AUM.

The fund aims to identify under-researched and under-owned small-cap stocks available at reasonable valuations that possess the ability to demonstrate high earnings growth potential. It maintains a small-cap-biased portfolio and also carries significant exposure towards the mid-cap segment, which has helped it capitalise on the broad-based market rally seen in recent years.

In the last 3 years, HSBC Small Cap Fund has recorded growth at a CAGR of 31.7% on a rolling return basis, higher than the growth of 27.6% in the benchmark Nifty Smallcap 250 - TRI index.

Its top holdings mainly comprise small-cap and mid-cap names such as Neuland Laboratories, Apar Industries, Aditya Birla Real Estate, Kirloskar Pneumatic Company, and BSE. The fund avoids concentrating its assets and has balanced exposure across diverse sectors such as Finance, Engineering, Infrastructure, Pharma & Healthcare, Auto Ancillaries, and Infotech, among others.

In its decade-long journey, HSBC Small Cap Fund has been through phases of outperformance as well as underperformance and has managed to reward investors with satisfactory gains over the long run. Moreover, the fund has achieved this without exposing the portfolio to undue risks, resulting in decent risk-adjusted returns.

HSBC Small Cap Fund maintains a well-diversified portfolio across sectors to avoid concentration risk, which has helped it perform well over complete market cycles. Additionally, with experienced fund managers at the helm, the fund has benefitted from stable growth in the portfolio.

Conclusion

Small Cap Funds have registered a strong performance in recent years and have rewarded investors with impressive returns. However, it is important to note that superior performance in the past may not sustain in the future. As mentioned earlier, the BSE Smallcap to Sensex ratio, a measure of valuation in the small-cap segment is currently at its peak, indicating overstretched valuations in pockets of the small-cap segment. Thus, the margin of safety has reduced compared to that of large caps.

With market near its peak and with various global and domestic headwinds at play, the possibility of earning massive returns in the near future may be limited. Since the downside risk and volatility associated with small-cap stocks tends to be high, investors need to assess their holdings in Small Cap Funds to ensure that they do not go overboard with the investments.

Only aggressive investors having high risk appetite and a long-term investment horizon should consider adding Small Cap Funds to their portfolio, preferably via the SIP mode of investment.

Note: This write up is for information purpose and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Registration granted by SEBI, Membership of BASL and certification from NISM no way guarantee performance of the intermediary or provide any assurance of returns to investors.

The securities quoted are for illustration only and are not recommendatory.

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.