Is investing in an active small-cap fund still a good idea?

Summary: Passive investing has quietly become the badge of financial wisdom among India’s money-smart investors: own the market, skip the guesswork, pay lower fees. Large-cap index funds, which simply track benchmarks like the Nifty 50, have started delivering returns that beat most actively managed peers. Naturally, many investors ask: can this passive approach work in small-caps, too?

Passive investing has quietly gone from being a niche strategy to a badge of financial wisdom among India’s money-smart investors. The idea is simple: stop trying to beat the market; just own the market.

Passive investing, which involves putting money in an index fund or ETF (exchange-traded fund), simply mimics a benchmark — say, the Nifty 50 — at a fraction of the cost of an actively managed fund. And in the last few years, large-cap index funds have started delivering better returns than many actively managed large-cap funds. With lower fees and zero dependence on fund managers, passive investing has its appeal.

So, the next logical question is: should you go passive across the board: large caps, mid caps and even small caps?

That’s where things get interesting.

Ten-year performance of small-cap funds

There are 13 actively managed small-cap funds with at least a 10-year history. We looked at how they performed over the last decade, from September 22, 2015, to September 22, 2025.

Over this period, the Nifty 250 Smallcap TRI — the benchmark for the small-cap category — delivered a stellar 17.38 per cent annualised return. That’s already very respectable. But here’s the kicker: 10 of the 13 active small-cap funds outperformed this benchmark over the same period.

That said, a one 10-year window may not be enough. What if it’s a flattering timeframe, skewed by one bull run?

Enter rolling returns

This is why we use rolling returns, a far better test of consistency.

Think of rolling returns like taking a movie not just at the premiere but on every single day of its run, then averaging the box office numbers. For funds, rolling returns calculate performance for overlapping timeframes — say, every possible five-year period between 2020 and 2025 — so you know how often a fund would have actually delivered for an investor starting at any random date.

We looked at five-year daily rolling returns for all 13 small-cap funds between September 21, 2020, and September 19, 2025, and here’s what we found:

• The Nifty 250 Smallcap TRI delivered an annualised five-year return of 18.07 per cent during this period.
• 12 of the 13 active funds outperformed this average, and 10 of them delivered over 20 per cent returns.
• The frontrunners were:
  • Quant Small Cap Fund: 29.34 per cent annualised return
  • Nippon India Small Cap Fund: 25.45 per cent
  • Axis Small Cap Fund: 24.06 per cent

How many times did active small-cap funds beat their benchmark?

It’s one thing to have a high average return. But what about your odds of actually beating the benchmark if you had invested on any random day and stayed for five years?

Here’s what the numbers say:

• Nippon India Small Cap, HDFC Small Cap and HSBC Small Cap Funds beat the benchmark (Nifty Smallcap 250 TRI) 100 per cent of the time during this five-year period.
• Quant Small Cap Fund came very close, outperforming 97.5 per cent of the time.
• Only two funds failed to beat the benchmark more than half the time.
• Even if you raise the bar and ask, “How many active small-cap funds beat the benchmark at least 60 per cent of the time?”, which is a fair expectation given their higher expense ratios, 10 of the 13 funds clear the benchmark hurdle over the long run.

Put simply, if you had invested in any of the top-performing active funds and exited five years later, no matter which day you started, you would almost certainly have beaten a passive small-cap index investor.

And this doesn’t even account for tracking error — the small but real gap between index returns and what you actually get — or other issues with passive investing, such as lack of flexibility in volatile markets and no scope for avoiding poor-quality stocks in the index.

Why active small-cap funds still work

So, why do active small-cap funds still have an edge when large-cap funds are struggling against index funds?

1. Information advantage
   Small-cap stocks are not tracked as widely as large caps. That means skilled fund managers can find underpriced gems before the market notices.
2. Higher dispersion
   In small caps, the difference between the best and worst performers is massive. A good fund manager who can avoid the duds and focus on quality businesses can dramatically outperform the index.
3. Active risk management
   Small caps can fall hard in bear markets. Active managers can hold cash, reduce exposure or rotate into more resilient businesses, something an index can never do.
4. Liquidity management
   Some small-cap stocks are thinly traded. Active funds can stagger their buying and selling to avoid pushing prices up or down too much, unlike an index that has to rebalance mechanically.

The case for staying active in small-caps

Passive investing is a great idea in large-caps (only 9 of 26 large-cap funds have beaten their benchmark), where information is efficient and active managers struggle to add value. But small-caps are a different ball game.

Our analysis shows that 10 out of 13 active small-cap funds beat the benchmark more than 60 per cent of the time over the last five years. Three funds — Nippon, HDFC and HSBC — did it every single time. That kind of consistency is not just luck, it’s process.

Of course, active small-cap funds come with higher costs and higher volatility. You still need to choose wisely, diversify and stay invested through inevitable downturns. But the data suggests they remain a better bet than going passive in this space, at least for now.

Which small-cap funds are recommended by us?

Explore Value Research Fund Advisor

Also read: Active vs passive investing: Which is right for you?