Assessing liquidity: Stress test results for small-cap mutual funds

Mutual funds are now required to undergo stress tests. A few months back, the Securities and Exchange Board of India (SEBI) instructed the Association of Mutual Funds in India (AMFI) to conduct stress tests for all small and mid-cap mutual funds. The purpose is to assess their liquidity positions and update the findings every 15 days from March 15, 2024. Stress testing evaluates how resilient companies and investment portfolios are against potential future financial challenges. It helps measure investment risk, asset sufficiency, and assess internal processes and controls.

During stress testing, small-cap mutual funds may take longer to fulfill redemption requests compared to large- and mid-cap funds. This is because selling shares of smaller companies can be more challenging. Among large- and mid-cap funds, large-cap funds are likely to process redemptions more quickly.

SEBI’s mutual fund stress test evaluates how swiftly a mutual fund can meet redemption requests if 25% or 50% of investors seek to withdraw their investments during extreme market conditions.

New results:

The latest results from the mutual fund stress tests have unveiled some interesting findings regarding the liquidity positions of various small-cap funds. Let’s delve into the key highlights:

• SBI Small Cap Fund has notably improved its liquidity parameters, now taking 48 days to liquidate half of its portfolio, down from 58 days previously. Similarly, it requires 24 days to sell 25% of the portfolio, compared to 29 days earlier.
• Tata Small Cap Fund has also shown significant improvement, with the scheme now needing only 23 days to sell half of its portfolio, down from 29 days in March.
• Conversely, HDFC Small Cap Fund has witnessed a decline in liquidity, now requiring 54 days to liquidate 50% of its portfolio, compared to the previous 44 days. For 25% liquidation, it previously took 22 days, but now it takes 27 days. DSP Small Cap Fund has experienced a similar trend, with an increase in the number of days needed for both 25% and 50% liquidation.

However, funds like Baroda BNP Paribas Small Cap Fund and ITI Small Cap Fund have remained unchanged.

Overall, the third batch of mutual fund stress test results indicates a slight decline in the liquidity positions of small-cap funds. On average, these funds now take approximately 14.46 days to liquidate half of their portfolios as of March end.

In summary, while the liquidity positions of small-cap funds may fluctuate, it’s essential for investors to consider diversification and allocate their investments across different market caps to effectively manage risk.

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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet, and is subject to changes. Please consult an expert before making related decisions.