Small-cap sell off intensifies as MTF funded positions unwind

The recent unwinding of leveraged positions through the MTF (margin trading facility) has led to a significant sell-off in small-cap stocks, causing the Nifty small-cap 250 index to plummet 5% to 16,764 points on Friday from 17,589 points in September. Despite this downturn, the broad Nifty index remains up 2% at 23,053 points over the same period.

The average MTF fund in October has decreased to ₹1.51 lakh crore from ₹1.56 lakh crore in September, as traders react to concerns over the earnings of small-cap companies. With rising interest rates and tighter funding from banks, investors are increasingly relying on MTF to make risky bets. Care Edge Ratings' data shows a consistent growth in MTF book size from ₹96,000 crore in August 2025 to ₹1.48 lakh crore in August 2026.

A significant portion of MTF book, ₹1.44 lakh crore, is held by the NSE, while BSE holds ₹7,405 crore. NSE has flagged brokers for violations, including inadequate margins, funding against ineligible stocks, and lapses in monitoring authorized persons. Pankaj Agrawal, Director of Valmiki Leela Capital, warns that a decline in small-caps could pressure blue-chip stocks, as investors may need to sell them to meet repayment obligations.

Despite the current market conditions, SIP investments have helped support the market, but valuations cannot rise indefinitely without adequate earnings support. Rising interest rates could pose further challenges for small-cap companies, especially those dependent on borrowing for operations or expansion. The Nifty small-cap 250 has been trading at 32 times its five-year average of 27 times, driven by steady mutual fund inflows.

However, near-term valuation concerns persist, particularly in mid- and small-cap schemes where certain valuations have become stretched. Despite these challenges, investors who have maintained their investments for 4-5 years have seen strong returns in these segments.