Fund manager insights: Kirthi Jain of Bandhan AMC on small-cap investment strategy, risks and more

Jain believes the risk-reward in small caps has turned more favourable compared to two years ago, but he cautions against aggressive lump sum deployment. Instead, he recommends a calibrated increase in allocation, preferably through systematic investment plans (SIPs), to better manage volatility and behavioural risks.

In an exclusive interview with Upstox, Jain says, small-cap investing is a long-term compounding journey. It rewards patience, discipline and realistic expectations.

Valuations are coming more towards the fair value zone for many companies, and the earnings base is also favourable, and the demand scenario is also improving. Hence, we see this space quite favourably.

We recommend a calibrated increase in allocation for small-cap stocks, as space has become more attractive compared to two years back.

Yes, for most retail investors, SIP is generally the better route in small-cap funds, primarily because of volatility management and behavioural discipline.

Small-cap funds tend to be more volatile than large-cap indices like the Nifty 50, with sharper drawdowns and stronger recoveries.

A lump sum investment exposes the investor to significant timing risk; if invested near a market peak, short-term losses can be steep and emotionally difficult to handle.

SIP, on the other hand, spreads investments across market cycles, enabling rupee cost averaging and reducing the impact of market timing.

The ideal allocation to small caps in a diversified equity portfolio depends on risk appetite, investment horizon, and overall portfolio structure, but for most retail investors, a measured exposure works best.

Based on the risk appetite, the following can be general guidelines that the investors can follow:

• Conservative investors: 0 – 10%

• Moderate investors: 20–30%

• Aggressive investors: 30–40%

That said, the above allocation should apply only to the portion of the portfolio that the investor is willing to remain invested for at least five years.

If we look at the returns standard deviation data for the index, volatility reduces significantly as the investment horizon crosses 5 years.

_Data Source: NSE, Index Name: Nifty Smallcap 250 Total Returns Index. Data from 1-Apr-2005 to 31-Dec-2025. _

Standard deviation calculated for rolling returns for the mentioned period.

Hence, we believe that investors should have at least 5 years investment horizon if they want to invest in small-cap funds. Investors with a horizon below five years may find small-cap volatility uncomfortable.

Many investors make the mistake of chasing recent outperformance in small-cap funds, entering after a strong rally when past returns look attractive, and valuations are already stretched.

Small caps are highly cyclical, and what performs best in one phase can correct sharply in the next. Investors often underestimate the volatility of this segment, as small caps can fall significantly more than broader indices like the Nifty 50 during downturns.

A short investment horizon further amplifies risk, as small caps may underperform for extended periods before recovering.

Another common mistake is over-allocation driven by return expectations rather than risk capacity. Investors should evaluate the fund’s investment philosophy and the risk management framework implemented by the fund manager to sustainably generate returns.

The category recorded total net inflows of over ₹50,000 crore during the calendar year 2025. Yes, with rising retail participation in equity markets, small-cap funds are increasingly showing signs of crowding, though the implications deserve a balanced view.

Greater retail inflows can drive valuations higher and compress future return potential, especially during periods of strong market sentiment.

Small-cap stocks typically have lower liquidity and smaller free float compared to large- and mid-cap stocks, so increased buying pressure can lead to larger price moves and steeper valuations that are less tied to fundamentals. This can create short-term momentum, but it also raises the risk of sharp reversals if sentiment changes.

If I had to give one piece of advice to a first-time small-cap investor, it would be this: enter with patience, not expectations of quick gains.

Small-cap investing is a long-term compounding journey, not a short-term momentum trade. Be mentally prepared for sharp volatility and periods of underperformance and commit capital that you won’t need for at least the next 5–10 years.

If you stay disciplined through cycles instead of reacting to them, small caps can reward you, but only if you give time the chance to work in your favour.

Disclaimer: This article is written purely for informational purposes and should not be considered investment advice from Upstox. Investors should do their own research or consult a registered financial advisor before making investment decisions.