Your Small-Cap Fund Has Become a Monster – Here's How to Tame It

Let me tell you something that happened to a friend last week.

He called me. Voice a little shaky. Not because he lost money – actually, the opposite.

"Yaar, I checked my portfolio after six months," he said. "I thought I was a moderate investor. 60% large caps, 20% mid, 10% small, 10% debt. That was the plan."

"Okay. So what's the problem?"

"Small caps are now 43% of my total portfolio."

I laughed. He didn't.

Here's the thing – he didn't buy more small-cap funds. He didn't get greedy. He just... forgot to check. And the small-cap rally did the rest.

If this sounds familiar, you are not alone. Millions of Indian investors are walking around with portfolios that look nothing like what they originally planned.

And right now – in this May-June reinvestment window – is exactly when you should fix it.

How Did This Happen? (Spoiler: It's Not Your Fault)

Let me explain what happened to your portfolio without using any complicated words.

Two years ago, small-cap funds went on a tear. The Nifty Smallcap 100 index surged 93% in 2023 and 2024 combined . That is almost doubling in two years.

Meanwhile, large-cap funds grew, but slowly. Like a tortoise next to a rabbit.

So even if you put just 15% of your money into small caps two years ago, that 15% might have grown into 30% or 40% of your portfolio today. Not because you bought more. Because those stocks ran like crazy.

Here is the data from April 2026 that proves this is happening to everyone:

• Small-cap funds attracted ₹6,886 crore in April alone – up from ₹3,881 crore just two months earlier

• Mid-cap funds pulled in ₹6,551 crore

• Flexi-cap funds (which can invest anywhere) got ₹10,148 crore

Everyone is chasing the smaller companies. And the rally is feeding on itself.

But here is what no one tells you at the party: What goes up 93% can also come down 40-50% when the music stops.

The Warning Signs Are Already Blinking Red

I am not saying sell everything. I am saying: wake up.

Warning Sign 1: Valuations are nuts.

The Nifty Smallcap 100 is trading at 22.6 times one-year forward earnings. That is a 30% premium to its historical average .

The Nifty Midcap 100 is at 27.6 times – a 16% premium .

The Nifty 50? 19.1 times. Actually 9% below its long-term average .

In plain English: You are paying luxury prices for small caps while large caps are on sale.

Warning Sign 2: History says this ends badly.

I hate to be that person. But someone has to say it.

After the 2008 crash, the small-cap index took until 2016 to return to its previous level. That is eight years.

From 2018 to 2020, small caps saw a 65% correction. Ninety percent of stocks fell more than 50% .

Devina Mehra, Chairperson of First Global, put it perfectly: "People forget history and how long these pockets of the market can give you pain" .

Warning Sign 3: Even fund houses are getting nervous.

Several mutual fund houses have already halted or restricted inflows into small- and mid-cap schemes. That is not something they do when they are excited. That is something they do when they are worried.

Dhananjay Sinha, CEO at Systematix Corporate Services, said: "Volatility and illiquidity premia in small-caps are hugely underpriced right now" .

Translation: When the tide turns, there won't be enough buyers. Your small-cap fund could fall much faster and harder than the rest of the market.

So What Does a Healthy Portfolio Look Like?

Let me give you a simple rule. Not advice. Just a rule of thumb that most financial planners agree with.

For a Conservative Investor (close to retirement or low risk appetite):

• Large caps: 40% to 50%

• Mid caps: 10% to 15%

• Small caps: 0% to 5%

• Debt or hybrid funds: 40% to 50%

For a Moderate Investor (5-10 years away from goal, medium risk):

• Large caps: 40% to 50%

• Mid caps: 15% to 20%

• Small caps: 10% to 15%

• Debt or hybrid funds: 20% to 30%

For an Aggressive Investor (10+ years away, high risk appetite):

• Large caps: 30% to 40%

• Mid caps: 20% to 25%

• Small caps: 15% to 20%

• Debt or hybrid funds: 10% to 20%

Notice something? Even aggressive investors rarely go above 20% in small caps.

If your small-cap allocation is 30%, 40%, or – God forbid – 50% of your portfolio, you are not aggressive. You are gambling.

How to Fix Your Portfolio Without Crying About Taxes

Here is the step-by-step plan. Do it this month. May-June is the perfect time because you are already reviewing your investments anyway.

Step 1: Find out where you actually stand.

Log into your mutual fund dashboard. Look at the portfolio breakdown. Most apps show you "large cap %", "mid cap %", "small cap %". Write them down.

Be honest with yourself. If small caps are above 20%, you have work to do.

Step 2: Stop new SIPs into small-cap funds.

Right now. Today. Do not add more fuel to the fire.

Switch those SIPs to a flexi-cap fund or a large-cap fund. The money will still grow. Just with less risk.

Step 3: Trim the excess – but do it smartly.

You do not have to sell everything. But if small caps are 40% of your portfolio and you want them at 20%, you need to sell half.

Here is how to sell without crying:

• Sell only the units that are older than 1 year (so you pay only 10% LTCG tax on gains above ₹1 lakh)

• Sell in phases – 25% now, 25% in July, 25% in October

• Do not reinvest the money immediately into large caps. Park it in an arbitrage fund or a liquid fund for 2-3 weeks. Let the market breathe.

Step 4: Move the money to where it belongs.

Where should the money go? Three options depending on your risk profile:

• Option A (Safest): Large cap index fund or bluechip fund

• Option B (Balanced): Flexi-cap fund (let the fund manager decide where to invest)

• Option C (Conservative): Aggressive hybrid fund (65% equity, 35% debt)

Do not move everything to mid caps. That is just jumping from one fire to another. Mid caps are also expensive right now.

Step 5: Set a reminder to check every 6 months.

This is the most important step. And also the most boring. But boring is what saves you from disaster.

Put a calendar reminder for December 2026 and June 2027. "Check portfolio allocation." That is it. Five minutes of work every six months.

What About Your Existing Small-Cap Funds? Should You Sell Everything?

Let me be honest. Not everything in small caps is bad.

Some small-cap funds are managed by excellent fund managers who have beaten their benchmarks consistently. PPFAS, Quant, and Nippon have strong track records .

But here is the catch: Even the best fund manager cannot save you from a market crash.

If the small-cap index falls 30%, your small-cap fund will fall 25-30%. No magic wand.

So here is my simple rule:

• Keep what you have if you are comfortable with the risk and you have a 7+ year time horizon

• Do not add more through new SIPs or lumpsum investments

• Trim aggressively if you are within 3-5 years of needing the money

The Bottom Line

Let me sum this up like I would tell my own younger brother.

Small caps have been partying for two years. They have doubled. It has been fun. But the party is getting expensive. The drinks are overpriced. And history says the hangover can last for years.

You do not need to leave the party entirely. But you should definitely stop ordering more bottles. And maybe call a cab to take some of your money home.

Here is your to-do list for this week:

• Check your portfolio allocation right now

• If small caps are above 20-25%, you have a problem

• Stop new SIPs into small-cap funds immediately

• Trim the excess in phases – don't sell everything in one day

• Move the money to large caps, flexi caps, or hybrid funds

• Set a reminder to check again in December

May and June are the reinvestment season. Use this window to fix your portfolio before the next storm hits.

Because storms always come. And when they do, you want to be wearing a raincoat – not standing outside in a t-shirt.

Disclaimer: This article is for informational and educational purposes only. It does not constitute investment advice, recommendation, or solicitation to buy or sell any securities. Readers should conduct their own research or consult a SEBI-registered financial advisor before making any investment decisions. Equity investments are subject to market risks, and past performance does not guarantee future results.