India's pension regulator has revised investment rules for pension funds, allowing more diversification and subsequently better returns. Analysts explained why this is expected to benefit midcap stocks more than smallcaps.
The Pension Fund Regulatory and Development Authority (PFRDA) on December 10 announced that it will now let private pension funds to invest in the top 250 stocks by market capitalisation listed on Indian stock markets.
Earlier, these funds could only invest in a list of 200 stocks approved by the trust of the National Pension Scheme. PFRDA has now also permitted these funds to invest in gold and silver ETFs, which have seen strong surge this year so far.
The changes, which were announced in a circular on Wednesday and came into effect immediately, are aimed to increase the popularity of pension funds by allowing a wider suite of investment options of customers.
Midcaps are the 'clear winners':
PFRDA's revised norm related to allowing private pension funds invest in top 250 companies is a clear positive for midcaps ranked between 201 to 250, said Naren Agarwal, CEO of Wealth1. "It brings a new class of long-horizon, rules-based buyers into the tail of the Midcap 150, improving liquidity, index inclusion stability and price discovery in that cohort," he said.
With the private pension ecosystem now overseeing approximately Rs 1,500–1,600 crore in assets, even modest equity allocations can create steady, "non-hot-money" demand for qualifying midcaps, especially the profitable, free-float-friendly names in industrials, manufacturing, and services, the analyst said.
Naren Agarwal expects bid-support to be most visible around rebalancing windows and new-fund launches, with the benefit accruing over quarters rather than days.
Abhinav Tiwari, Research Analyst at Bonanza, noted that PFRDA's expansion will help both midcap and smallcap stocks, but the benefits will be stronger and more direct for midcaps. "NPS inflows are 'sticky' since they come from regular contributions and not market sentiment, which helps support valuations even during corrections," he said.
Midcaps also tend to attract more institutional money than smallcaps because they offer better liquidity, more reliable disclosures and lower volatility, the analyst noted. "As funds compete within the top 250 stocks, many midcaps will enjoy more stable ownership and stronger valuation floors," he added.
Tiwari called midcaps the "clear winners" because of direct allocation and valuation support.
Ranju Ranjan, Head of Managed Accounts at Axis Securities, agreed with the other two analysts that midcaps will benefit from the rule change. "These companies will now qualify for steady, long-term institutional inflows that can improve liquidity, reduce volatility, and potentially support valuation re-rating. Since pension funds are large and conservative investors, the newly eligible midcaps may see more stable demand over time. Overall, the rule change structurally benefits midcaps the most, while smallcaps remain largely unaffected as they still fall outside the investable universe," the analyst said.
Which midcap stocks may benefit from the rule change?
According to latest data from the stock markets, some of the notable names among the stocks ranking between 201 and 250 in terms of market capitalization include Kalyan Jewellers, National Aluminium Company Limited (NALCO), Mahindra & Mahindra Financial Services, 360 ONE WAM, Hexaware Technologies, Voltas, Balkrishna Industries, Bank of Maharashtra, Godfrey Phillips, United Breweries, JK Cements, Radico Khaitan, HUDCO, Cochin Shipyard, Premier Energies, Supreme Industries, ITC Hotels, Jubilant Foodworks, CONCOR, IREDA, PhysicsWallah, Poonawalla Fincorp, UCO Bank, Cholamandalam Financial Holdings, Tata Investment Corporation, Apar Industries, Blue Star, Hindustan Copper and Godrej Industries.
Why won't smallcaps directly benefit from the rule change?
Agarwal from Wealth1 noted that the latest rule change does not unlock incremental flows into smallcaps, whose market capitalization do not bring in a rank below 250. If anything, the move could widen the liquidity gap between late-midcaps and true smallcaps, making stock-selection and governance premia matter even more below the cut-off, the analyst said.
However, Agarwal noted that the flow will be gradual as pension funds' equity caps and glide-paths limit one-off surges and parts of midcaps already trade with rich valuations. "So fresh demand will still discriminate on earnings quality, cash conversion and disclosure standards. Net-net, the change structurally favours midcaps at the boundary, while smallcaps must continue to earn capital the hard way—through delivery, not taxonomy," he added.
Abhinav Tiwari from Bonanza meanwhile said that smallcaps may see some indirect positives from the rule change, but the structural exclusion from pension funds remains a major limitation.
Also read: Sensex settles 400 pts higher, Nifty ends above 25,850
(With inputs from Reuters)
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