Why retail investors continue to root for the underdogs

India’s retail investor landscape is undergoing a dramatic transformation. While a diverse range of stocks has captured the fancy of individuals fishing in the equity markets, the mid-cap and small-cap segment—perceived as riskier but with higher potential returns—remains a key draw.

Despite recent price fluctuations, these stocks have seen a surge in retail interest.

About 56% of mid-cap stocks and 72% of small-cap firms analysed by Mint witnessed a sequential rise in retail investor count during the September quarter. In contrast, fewer than half of the stocks in the benchmark Nifty 50 index experienced a similar increase, Mint’s analysis shows.

Among the 127 mid-cap stocks analysed by Mint, 7.1% even added more new individual investors in the financial second quarter than they had in the preceding one. Despite nearly a third of these mid-cap stocks experiencing a share price decline during the September quarter, over 42% managed to grow their retail investor count in that period.

Among mid-cap stocks, Yes Bank Ltd, state-run hydropower firm NHPC Ltd and wind turbine maker Suzlon Energy Ltd attracted over a million new retail investors between the July-September quarters of 2023-24 and 2024-25.

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According to market observers, the retail rush to small- and mid-cap stocks is driven by younger, risk-tolerant individuals. “Over the past four years, small- and mid-cap stocks have consistently generated the highest returns, resulting in significantly increased participation in this market segment,” said Abhishek Shah, co-fund manager at Wallfort PMS.

Among small-cap stocks, 72% of 845 companies analysed by Mint grew their retail investor base in the second quarter. For nearly 29% of the companies, the number of individual investors they added in the September quarter outshone the additions they had made in the previous June quarter.

IRB Infrastructure Developers Ltd stood out among the small-cap stocks, gaining more than a million new retail investors between the financial second quarters of FY24 and FY25. Even as 38% of the small-cap stocks analysed faced price drops, 42% still managed to attract more investors.

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Mutual fund route

Mutual funds offer retail investors a diversified route to invest in mid-cap and small-cap stocks. In the July-September quarter, small-cap funds attracted the highest inflows from investors, garnering ₹8,389.4 crore, followed by mid-cap funds with ₹7,829.33 crore, and large-cap funds with ₹5,076.40 crore.

In the first half of 2024-25 (April-September) too small-cap funds led, with inflows of ₹15,586.22 crore, while mid-cap funds attracted ₹14,755.93 crore and large-cap funds received ₹7,067.54 crore, show data from the Association of Mutual Funds in India (AMFI).

“Retail participation is increasingly happening through mutual funds, especially thematic funds. Sectoral schemes like those focused on (public sector undertakings), manufacturing, and healthcare require mutual fund investments in small- and mid-cap stocks, bringing greater liquidity to these segments,” said Riya Oswal Bafna, co-fund manager at Purnartha Investment Advisors.

The fear-of-missing-out (FOMO) factor also plays a key role, said Divam Sharma, founder and fund manager at Green Portfolio. “The retail investor is no longer limited to just large-caps and mutual funds. The fear of missing out also plays a part here as investors see people make money in the small-cap space. Investors are seeing immense growth in the small-cap space and they want to be a part of the party.”

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Pricey tag

The recent market correction has hit mid-cap and small-cap stocks hard, with both indices down nearly 10% from their peaks in September. The broader Nifty50 and Sensex indices too have lost nearly 10% since climbing to record highs in September.

However, on a year-to-date basis, mid-cap and small-cap stocks have outperformed. The BSE Midcap index gained 21% and the BSE SmallCap index about 23% in the year to 19 November, compared to the Sensex’s more modest 7.4% return in that period. (The markets were closed on 20 November on account of the election in Maharashtra, home to BSE.)

Despite the recent correction across categories, several stocks still command premium valuations, indicating that they may be vulnerable to further price declines.

The BSE Midcap index is currently valued at 26.8 times on a one-year forward earnings basis, exceeding its five-year historical average of 23.7. The BSE SmallCap index is valued at 21.7 times, trading at a 17% premium to its five-year average.

“The small- and mid-cap indices have given spectacular returns lately and investors are eyeing those big returns,” said Sharma of Green Portfolio. “Post-covid, we have been seeing an increase in the risk appetite of investors. This is supported by the abundance of opportunities available in the small- and mid-cap spaces.”

Sharma expects retail investor participation in small-cap and mid-cap stocks to continue undeterred by the recent market correction. “We do not see the overall investor sentiment turning negative. Retail investors have even ventured into small- and micro-cap spaces with a higher risk appetite than ever before,” he said.

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Some analysts argue that the current market volatility is insufficient to establish a clear and enduring trend. 

“Historically, markets cycle through phases of greed and fear,” said Shah of Wallfort PMS.

“Recent corrections have been brief, often lasting just days, sparing investors from prolonged downturns. With returns robust, liquidity should remain healthy. It will be revealing to observe how investors respond after an extended period of market distress.”