Why owning 'more' small-cap stocks can be a winning strategy

Summary: The concentrated-versus-diversified debate is old. But the five-year returns of the Nifty Smallcap 250 index and the Nifty Smallcap 50 index settle it with clarity that investors cannot afford to ignore.

A few days ago, we worked on a story that surprised readers: two of the three best-performing small-cap funds — Nippon India Small Cap and Bandhan Small Cap — each held more than 200 stocks in their portfolios, and yet, despite such seemingly bloated portfolios, both funds were comfortably outpacing their peers.

This goes against the grain of what most investors assume.

Conventional wisdom says a small-cap fund should ideally hold 50–100 high-conviction ideas, because:

• Too many stocks can turn into diworsification. You diversify so much that your winners do not matter.
• Spreading the portfolio across 200-plus companies means lower allocation to each stock, limiting the impact of potential multibaggers.
• A large roster can signal that a fund has run out of differentiated ideas and is simply accumulating whatever liquidity allows.
• And broadly, a concentrated portfolio feels more ‘intelligent’, whereas a bloated portfolio may give out signals that the fund manager is taking too many shots in the dark.

But the data tells a different story. In small caps, strength in numbers is not a bug; it is often an advantage.

The parallels between small-cap investing and Golden State Warriors

Allow me a quick detour.

In the 2010s and early 2020s, the Golden State Warriors transformed themselves into a dynasty by relying on their ‘strength in numbers’ philosophy. Yes, they had superstars in Steph Curry, Kevin Durant and Klay Thompson. But what made them unstoppable was a deep roster, a system where numerous role players created support, stability, teamwork and surprise bursts of impact that powered them to four NBA championships.

Small-cap funds, surprisingly, seem to thrive on the same principle.

While some managers may be forced to hold more stocks as their fund size grows, the benefits show up elsewhere, too, something we had mentioned in a recent article:

“In small caps, the return pattern is brutally uneven: a tiny fraction of companies generate a disproportionate share of the gains. The challenge, of course, is that identifying these future stars before they break out is almost impossible. That’s where concentrated portfolios run into trouble. By narrowing their bets, they also narrow their chances of catching enough of these winners.

Nippon and Bandhan take a different route. Their breadth is a blessing (perhaps in disguise). Instead of trying to predict the next one or two champions, they position themselves to benefit from the dozens of small, unexpected winners that emerge every year in the small-cap universe. This diffuse structure matches the reality of the segment.”

And the behaviour of two small-cap indices proves this more convincingly than any anecdote.

Smallcap 250 vs Smallcap 50

Before diving into numbers, here is a quick primer:

• The Nifty Smallcap 250 TRI represents 250 small-cap companies — a broad, diversified slice of the market.
• The Nifty Smallcap 50 TRI contains only the 50 largest small-cap stocks and, therefore, is more concentrated, ‘higher conviction’ and supposedly more potent.

The comparison mirrors the mutual fund world, where one small-cap scheme has a 50 to 80-stock portfolio versus those that have 200 to 250-stock portfolios.

Now the results.

1. The broad index wins, and by a clear margin

Based on average five-year annualised returns calculated daily between December 2020 and December 2025:

• Smallcap 250 TRI: 19.1 per cent
• Smallcap 50 TRI: 14.5 per cent

That is a 4.5 percentage point advantage, which is huge.

2. The dominance is almost absolute

Between December 2, 2020 and December 2, 2025, there are 1,232 five-year return observations. 

In other words, when we had to look at the Nifty Smallcap 250 TRI’s five-year return on December 2, 2025, we checked the index value between December 2, 2020 and December 2, 2025 and computed that five-year return. To calculate the previous observation, we checked the five-year returns from December 1, 2020, to December 1, 2025. Then the day previous, from November 30, 2020 and November 30, 2025. This continued day after day until we found the five-year return on December 2, 2020.

So, instead of just one five-year return, we got a fresh five-year return for every trading day between December 2, 2020 and December 2, 2025.

Based on this, the Nifty Smallcap 250 TRI outperformed the Nifty Smallcap 50 TRI every single day except one. That is over 99 per cent consistency.

3. More diversified, yet has more highs

A concentrated index should, in theory, give you sharper ups and downs:

• Worse lows in bad markets
• Better highs in good markets

But the numbers disagree.

• The Smallcap 50 TRI delivered muted 0-10 per cent returns one-third of the time.
• The Smallcap 250 TRI delivered such weak returns only half as often.

And during strong phases:

• The Smallcap 250 TRI delivered over 20 per cent five-year returns 43 per cent of the time.
• The Smallcap 50 TRI managed the same, only 34.5 per cent of the time.

In other words:

The concentrated portfolio had a lower low without delivering a higher high.

That is the worst possible trade-off.

So, how many small-cap stocks do you really need?

The head-to-head battle between the Smallcap 250 TRI and Smallcap 50 TRI reinforces one clear message. In small caps, breadth is not the enemy. In fact, it is often the edge.

Therefore, for investors, the message is that one should not restrict themselves to a tiny set of favourites. That’s because, in small caps, many good ideas can beat a few great ones more often than you think.

For more such insights, we suggest you check out Mutual Fund Insight, your no-nonsense guide to becoming a smarter investor.

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• Clear, data-backed fund analysis
• Expert-reviewed fund recommendations
• Deep dives into trends shaping your returns
• Practical, jargon-free lessons you can apply immediately

If you want to stay ahead of the market without drowning in noise, this is the one resource you should not miss.

Also read: How many small-cap funds should you invest in?