Market Volatility Hits Mid and Small-Caps: Are Large-Cap Stocks a Safer Bet Now?

As Indian equity markets navigate choppy waters amid global uncertainty and domestic macro pressures, investors are beginning to reconsider their exposure to mid- and small-cap stocks. These segments, which had outperformed for much of 2024, are now showing signs of fatigue. In contrast, large-cap stocks—often considered market anchors during turbulent times—are back in investor focus as a relatively safer haven.

Market Context: Broader Indices Under Pressure

The BSE MidCap and SmallCap indices have faced a sharp correction in recent weeks. As of Thursday's close, the BSE SmallCap index has fallen nearly 7.5% from its 2025 high, while the MidCap index is down by about 5.8%. In contrast, the Nifty 50 and Sensex have exhibited relative resilience, dropping less than 2% in the same period.

The divergence highlights the heightened sensitivity of smaller stocks to broader market volatility, profit-booking, and liquidity shifts—especially amid global cues such as uncertain U.S. interest rate direction, concerns over oil prices, and geopolitical unrest.

Analysts Weigh In: Caution on Valuations, Preference for Large-Caps

"Valuations in the mid- and small-cap space had run ahead of fundamentals," said Mahesh Patil, Chief Investment Officer at Aditya Birla Sun Life AMC. “What we're seeing now is a healthy correction. This segment saw an extraordinary rally in the last 12 months, and some moderation was long due.”

Several brokerages are revising their model portfolios, advising higher exposure to quality large-cap names. Defensive plays in sectors like FMCG, IT, and large private banks are gaining attention.

Ritu Arora, CIO at Allianz Global Investors, added, “With volatility rising and retail participation showing signs of stress, institutional money is moving back to blue-chip names. These companies offer visibility, stronger balance sheets, and less vulnerability to sudden macroeconomic shocks.”

Fund Flows Reflect Shifting Sentiment

Mutual fund flows mirror the changing investor sentiment. According to data from AMFI, net inflows into mid- and small-cap mutual fund schemes dropped by over 40% in May 2025 compared to March. Conversely, large-cap schemes witnessed a steady uptick in inflows during the same period.

Foreign Institutional Investors (FIIs), who had increased exposure to mid-cap growth stories in early 2025, are now seen realigning their bets. As per NSDL data, FIIs turned net sellers in small-cap equities in June, while increasing their positions in frontline IT and bank stocks.

Risks Facing Mid and Small-Cap Stocks

Several headwinds are contributing to the cautious tone toward mid- and small-cap stocks:

• Liquidity Crunch: These stocks are more susceptible to liquidity withdrawal, both from retail and institutional sources.

• Profit Booking: After significant outperformance, many investors are locking in gains.

• Earnings Concerns: A potential slowdown in earnings for export-led midcaps amid global demand uncertainty is weighing on sentiment.

• SEBI Surveillance: Increased regulatory scrutiny to curb speculative trading in the broader market has also added pressure.

“Many retail investors entered mid- and small-caps during the bull run without understanding the risks. The current correction may be a wake-up call,” warned Deepak Shenoy, founder of Capitalmind.

Large-Caps as a Defensive Strategy

In contrast, large-cap stocks have emerged as a relatively stable investment avenue. These companies typically offer:

• Stronger corporate governance

• Higher liquidity

• Greater analyst coverage and investor confidence

• Diversified business models less affected by sector-specific shocks

Sectors such as banking, IT, and large-cap pharma are witnessing renewed buying interest. Stocks like Infosys, HDFC Bank, Reliance Industries, and Larsen & Toubro have shown resilience, even posting modest gains in recent sessions.

“During uncertain times, capital gravitates toward safety. Large-cap companies offer predictable cash flows, making them attractive when volatility spikes,” noted Anjali Verma, Economist at Kotak Institutional Equities.

Investor Outlook: Tactical Allocation the Key

While large-caps may be the flavor of the season, experts advise a balanced and tactical allocation strategy.

“Investors should not abandon mid- and small-caps altogether. A staggered, SIP-based approach with a long-term view still makes sense,” suggested Vinod Nair, Head of Research at Geojit Financial Services.

Wealth managers are advising a 60:20:20 allocation ratio—60% to large-caps, 20% to mid-caps, and 20% to small-caps—for moderately risk-tolerant investors until market visibility improves.

Key Takeaways for Investors:

• Stick to quality names with consistent earnings and low debt.

• Avoid chasing high-beta stocks in uncertain environments.

• Consider large-caps for stability, especially in volatile phases.

• Maintain diversification and avoid portfolio concentration.

The recent correction in mid- and small-cap stocks is a timely reminder of the cyclical nature of equity markets. While these segments will continue to offer wealth creation opportunities in the long run, current market conditions suggest a flight to safety. Large-cap stocks, with their defensive appeal, may offer investors the much-needed cushion against ongoing volatility. As always, disciplined investing, diversification, and a clear understanding of risk tolerance remain paramount.