Small caps have beaten large caps by 21.5% in a year. Should SIP investors rebalance now? Experts explain

Small-cap indices have significantly outperformed large caps over the past year, leaving investors to decide whether to continue their systematic investment plans (SIPs) or redirect fresh investments towards large-cap funds.

While historical data suggests that periods of sharp small-cap outperformance can be followed by mean reversion, experts say investors should not change their investment strategy solely because of recent market movements.

The more important question for SIP investors is whether their portfolios have drifted from their intended asset allocation. Strong returns can increase the share of small- and mid-cap funds in a portfolio, making rebalancing necessary even if investors have not changed their monthly investments.

Vaibhav Porwal, co-founder of Dezerv, said investors should first assess their overall asset allocation rather than make decisions based on the performance of a particular market segment. The target mix across large-, mid- and small-cap funds, gold, debt and global equities should reflect their financial goals and risk appetite, he said.

Continue SIPs, but check whether your portfolio has become overweight in small caps

Bharath Rathore, executive director at Anand Rathi Wealth, advised investors to continue their SIPs according to their strategy. He said investors should not make allocation changes based only on market movements or valuation figures.

According to Rathore, midcaps were trading around 20% below their estimated fair value, while small caps were about 18% below it. The Nifty 50 was trading 16% below its estimated fair value, he said. These estimates suggest that the valuation argument is not limited to one market-cap segment.

Investors should instead assess whether their existing allocation remains aligned with their financial plan. Rathore said that if mid- and small-cap allocation is around 25% of the overall portfolio, there is no need to change course simply because of recent market performance.

Porwal said investors should first look at their overall asset allocation rather than the performance of a particular index. Their target mix across large-, mid- and small-cap funds, gold, debt and global equities should reflect their financial goals and risk appetite.

If small- and mid-cap funds have grown beyond their intended share of the portfolio, investors should rebalance. If their allocation remains within the planned limits, recent outperformance alone is not a reason to make changes.

“Stopping it because a segment looks expensive turns a systematic plan into a market call, which is the thing a SIP exists to avoid,” Porwal said, referring to ongoing SIPs.

He distinguished between a SIP, which determines how much an investor puts in each month, and rebalancing, which determines how the accumulated portfolio is distributed. Investors can continue their monthly investments while separately reviewing whether their existing holdings need adjustment.

Redirect fresh SIP money if small-cap gains have distorted your allocation

For investors who have been investing in small-cap funds for several years, the decision should depend on how much of their portfolio is now invested in the category.

Porwal said that after seven years of monthly investing, each new SIP instalment may represent barely 1% of the accumulated investment. Changing where that instalment goes may therefore have little impact on the overall portfolio, while disrupting an established investment habit.

If small-cap gains have pushed the holding above its intended allocation, the adjustment should focus on the accumulated corpus. Investors can discuss with their wealth manager how much to shift, over what period and at what tax cost.

Rathore offered a different route for investors whose small-cap allocation has risen beyond their target. He said they could begin rebalancing by redirecting fresh SIP money towards large- and mid-cap funds.

Rathore said investors could use an allocation of around 20-22% to small caps as a reference point when reviewing their portfolios. Porwal, however, emphasised that there is no single allocation that works for every investor. The appropriate mix depends on individual goals and risk appetite.

A five- to 10-year horizon does not remove the need to review valuations

For investors with a five- to 10-year investment horizon, Porwal said a year of outperformance should not change the financial goals that determine their asset allocation.

He suggested focusing on fund managers who are disciplined about valuations and select businesses through bottom-up research, rather than trying to switch between market-cap categories based on short-term market calls. Opportunities, he said, exist across large, mid and small caps.

Rathore said long-term investors should remain diversified across market capitalisations and maintain discipline through market fluctuations. He said investors with a long horizon could consider an equity allocation of up to 80%, with the remaining 20% in debt, depending on their circumstances.

He also pointed to the potential for earnings growth and said market corrections could offer investors an opportunity to increase their equity allocation. However, this should be assessed against their financial goals and existing portfolio rather than treated as a blanket instruction to invest more.

For SIP investors, the central distinction is between continuing a disciplined monthly investment and allowing the portfolio to drift away from its intended allocation. A strong run in small caps is not, by itself, a reason to stop an SIP. But if that rally has left an investor with more small-cap exposure than planned, rebalancing may be warranted.