Why the Quality Smallcap Quant Smallcase Is Lagging Despite a Smallcap Recovery?

One of the key reasons investors often hesitate to invest in smallcap stocks is the higher risk associated with their often unclear or unproven business models. The Quality Smallcap Quant (QSQ) smallcase aims to address this concern by focusing exclusively on high-quality smallcap stocks. Furthermore, it filters for companies that are also exhibiting positive price momentum, thereby increasing the potential for delivering superior returns. The smallcase targets a minimum of 10 such stocks, and in cases where sufficient qualifying stocks are not available, it allocates the remaining funds to Gold Bees as a temporary holding.

Let’s start off by looking at the key performance metrics of this smallcase since its launch, i.e. Dec ‘2020. Please bear in mind that the data set is between Dec ‘20 to July ‘25.

The table clearly indicates the superior performance of the smallcase, as during the specified period, the smallcase has delivered higher returns and better risk-adjusted returns coupled with lower maximum drawdown. 

However, the smallcase has faced challenges recently. Since October 1, 2024, it has declined by over 13%, underperforming the broader equity smallcap universe, which has fallen by approximately 6% during the same period. A couple of months ago, we wrote about what’s driving the market performance; you can read about it here.

While the broader markets, as represented by the Nifty 500 index, have declined by around 5.5% since October 2024, different investment styles have shown varying levels of performance beneath the surface. Specifically, in the context of the Quality Smallcap Quant smallcase, smallcap stocks have fallen by approximately 6% over the same period. However, both the momentum and quality investing styles have seen sharper corrections, each declining by nearly 20% since October 2024.

Since two of the key investment factors—momentum and quality—have been underperforming, the QSQ smallcase has lagged the broader smallcap recovery. While smallcap stocks have risen by approximately 19% since April 8, 2025, the QSQ smallcase has gained only 7.2% during the same period.

Momentum strategies typically focus on stocks that have shown strong recent performance. However, many of the top performers from 2023 and early 2024 either stagnated or corrected, leading to a breakdown in momentum signals. At the same time, with macroeconomic conditions stabilising, such as easing inflation and peaking interest rates, it looks like the market has shifted its preference toward cyclical, value-oriented, and high-beta stocks. These segments often include lower-quality names which experienced significant re-rating in early 2025. As a result, quality-oriented strategies have struggled to keep pace.

The recent underperformance of the Quality Smallcap Quant smallcase reflects the temporary weakness in its core investment factors—momentum and quality—despite a broader rebound in smallcap stocks. However, its long-term track record since December 2020 demonstrates the strength of its underlying strategy, which combines quality stock selection with positive price momentum. This becomes clear from the table below : 

The table highlights how the QSQ smallcase performed across different market cycles compared to the broader smallcap index.

During the growth phase, Quality Smallcap Quant outperformed the broader market. In the subsequent slowdown, it offered better downside protection, falling less than the index. However, it has lagged during the current rebound. It is important to understand that since QSQ didn’t decline as sharply during the correction, its recent lookback performance may appear weaker compared to the smallcap index, which rebounded from a lower base.

As market dynamics shift, the factors driving returns tend to rotate. Investors should recognise that while style-based strategies may face short-term challenges, the disciplined factor exposure offered by Quality Smallcap Quant remains well-positioned to benefit when momentum and quality factors regain favour. Patience and a long-term perspective remain key to capturing the full potential of such systematic strategies.

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of a SEBI recognized supervisory body (if any) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary. Windmill Capital Team: Windmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.