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Retail investors are increasingly investing in India's small- and mid-cap mutual funds, motivated by higher returns, structural tailwinds, and regulatory reforms, a report said on Monday. 

While mid-cap schemes recorded net inflows of Rs 5,331 crore in August, a 74.5 per cent increase YoY and small-cap funds saw inflows of Rs 4,993 crore, marking a 55.6 per cent rise YoY, large-cap funds only saw a net inflow of Rs 2,835 crore, marking a 7.5 per cent increase, the report from ICRA Analytics said.

The net inflow of mid-cap and small-cap fund categories went up 55.01 per cent and 22.01 per cent, respectively, since the beginning of this financial year.

Net AUM of mid-cap funds increased by 10.9 per cent on YoY basis at Rs 4.27 lakh crore, while that of small-cap funds increased by 9.56 per cent YoY at Rs 3.51 lakh crore in August 2025. Net AUM of large-cap funds increased by 5.86 per cent YoY at Rs 3.90 lakh crore.

“Large-cap companies are already mature and well-established. Their growth is often incremental and tied to macroeconomic cycles. In contrast, small and mid-cap firms have greater room to expand, innovate, and capture market share, leading to higher earnings growth," said Ashwini Kumar, Senior Vice President and Head Market Data, ICRA Analytics.

Further, large caps often trade at higher valuations due to their perceived stability, which may limit their upside potential. However, small and mid-caps are frequently undervalued, offering better price-to-earnings ratios and return on assets, he added.

Kumar said that recent government initiatives supporting MSMEs, improved corporate disclosures, and stress testing have created a favorable environment for small and mid-cap companies to thrive.

As of August 31, 2025, one-year returns (-3.8 per cent) for large-cap funds, (-3.9 per cent) for mid-cap funds, and (- 6.4 per cent) for small-cap funds.

Three-year returns were 13.5 per cent, 19.6 per cent, and 19.3 per cent for large-cap, mid-cap and small-cap funds respectively.