For someone investing in mutual funds, liquidity is a key factor. How long will it take a mutual fund to meet your redemption request? The Securities and Exchange Board of India (SEBI) has mandated an efficient way to find out: through mutual fund stress tests.
A small-cap mutual fund may take longer to honour your liquidation request compared to its large- and mid-cap counterparts, as shares of smaller companies may be more difficult to sell. Among large- and mid-cap, similarly, the former is likely to see quicker redemption.
The mutual fund stress test devised by the SEBI looks to assess the endurance of liquidity management in the scenario that 25 percent or 50 percent of investors ask for their money back, amid extreme market conditions. Join us as we explore the importance of stress testing, its methodologies, and the insights it offers into the resilience of mutual funds.
What is a MF stress test?
The Association of Mutual Funds in India (AMFI) has instructed its members to reveal stress test findings every 15 days in accordance with a recent directive from the capital markets regulator, SEBI (Securities and Exchange Board of India). The aim of these stress tests is to determine how quickly fund managers could liquidate portfolios in the event of investors seeking redemptions during unfavourable market conditions. The initial disclosure was anticipated by March 15 (read below for insights from the first disclosure).
Additionally, the SEBI and various fund houses have engaged in lengthy discussions regarding liquidity, culminating in the development of a stress test methodology.
Stress tests typically involve subjecting the entity to a series of hypothetical scenarios that represent extreme market conditions, such as sharp declines in asset prices, sudden changes in interest rates, or economic downturns. By analysing how the entity responds to these stress scenarios, analysts and investors can gauge its ability to withstand adverse conditions and identify potential vulnerabilities and risks.
In the case of mutual funds, stress tests help investors understand how the fund's holdings and investment strategy might perform during periods of market turmoil or volatility. This information is valuable for investors looking to assess the risk profile of a mutual fund and make informed decisions about their investment allocations.
However, note that just considering the stress test results is not enough for any redemption decisions you are considering. There are several other factors that need to be taken into account, namely performance, standard deviation, and tax implications.
Calculation methodology for mutual fund stress test
The Sebi, with the goal to test how quickly a mutual fund can meet redemption requests, has come up with a methodology for the mutual fund stress test. Below, we have simplified the test structure for you:
Liquidation of 25 percent and 50 percent of the portfolio: The stress test involves a pro-rata liquidation of either 25 percent or 50 percent of the portfolio. This aims to assess the amount of time a fund manager requires to liquidate holdings and answer redemption demands in the case that a significant number of investors demand it.
Removing the bottom 20 percent: The mutual fund stress test does not involve cutting the more illiquid part of the portfolio; a fund can remove the bottom 20 percent of the portfolio based on the assets’ liquidity. Thus, fund managers can retain any stocks they think need to be held longer for better gains.
Stress test results for small cap funds
Here are some of the mutual fund stress test results for February and March 2024, and what they mean for investors:
Small Cap Fund Scheme Name
AUM (Rs. Cr)
Days to Liquidate (March 2024)*
Days to Liquidate (February 2024)*
50% portfolio
25% portfolio
50% portfolio
25% portfolio
Aditya Birla Sun Life Small Cap Fund
4444.2
9
5
10
5
Axis Small Cap Fund
19029
27
13
28
14
BANDHAN Small Cap Fund
4384.93
4
2
3
2
BANK OF INDIA SMALL CAP FUND
939.69
2
1
2
1
Baroda BNP Paribas Small Cap Fund
1288.67
2
1
1
1
Canara Robeco Small Cap Fund
9401.09
8
4
14
7
DSP Small Cap Fund
13038.77
32
16
32
16
Edelweiss Small Cap Fund
3134.64
4
2
3
2
Franklin India Smaller Companies Fund
11539.64
13
7
12
6
HDFC Small Cap Fund
27573.21
44
22
42
21
HSBC Small Cap Fund
13401.24
14
7
15
8
ICICI Prudential Smallcap Fund
7172.45
11
6
10
5
Invesco India Smallcap Fund
3669.57
4
2
4
2
ITI Small Cap Fund
1762.82
2
1
2
1
Kotak Small Cap Fund
13881.69
34
17
33
17
LIC MF Small Cap Fund
208.67
1
1
1
1
Mahindra Manulife Small Cap Fund
3557.06
4
2
4
2
Motilal Oswal Small Cap Fund
1524.46
4
2
3
2
Nippon India Small Cap Fund
45248.33
29
15
27
13
PGIM India Small Cap Fund
1372.73
3
1
3
1
Quant Small Cap Fund
17382.89
20
10
22
11
QUANTUM SMALL CAP FUND
42.03
1
1
1
1
SBI SMALL CAP FUND
25434.98
58
29
60
30
Sundaram Small Cap Fund
2902.99
5
3
5
3
Tata Small Cap Fund
6236.38
29
15
35
18
Union Small Cap Fund
1294.63
2
1
2
1
UTI Small Cap Fund
3501.59
5
3
5
3
*Pro-rata liquidation after removing bottom 20% of portfolio based on scrip liquidity (considering 10% PV with 3x volumes)
Stress test results for mid cap funds
Here is the Stress Test & Liquidity analysis data of mid cap funds for March and February 2024.
Scheme Name
AUM (Rs. Cr)
Days to Liquidate (March 2024)*
Days to Liquidate (February 2024)*
50% portfolio
25% portfolio
50% portfolio
25% portfolio
Aditya Birla Sun Life Midcap Fund
4912.51
4
2
4
2
Axis Midcap Fund
25536.4
10
5
12
6
BANDHAN MIDCAP FUND
1101.95
1
1
1
1
Baroda BNP Paribas Mid Cap Fund
1790.26
2
1
1
1
Canara Robeco Mid Cap Fund
2011.5
2
1
2
1
DSP Midcap Fund
15968.66
16
8
17
9
Edelweiss Mid Cap Fund
5064.54
2
1
2
1
Franklin India Prima Fund
10108.06
5
2
4
2
HDFC Mid-Cap Opportunities Fund
60418.7
24
12
23
12
HSBC Mid Cap Fund
9740.79
5
3
7
4
ICICI Prudential MidCap Fund
5517.26
2
1
2
1
Invesco India Midcap Fund
4280.25
3
2
3
2
ITI Mid Cap Fund
744.06
1
1
1
1
JM Midcap Fund
825.47
1
1
1
1
Kotak Emerging Equity Fund
39684.85
30
15
34
17
LIC MF Mid Cap Fund
242.21
1
1
1
1
Mahindra Manulife Mid Cap Fund
2201.78
1
1
1
1
Mirae Asset Midcap Fund
14251.88
8
4
8
4
Motilal Oswal Midcap Fund
8986.69
10
5
10
5
Nippon India Growth Fund
24796
8
4
7
4
PGIM India Midcap Opportunities Fund
9923.65
5
2
4
2
Quant Mid Cap Fund
5891.51
7
3
6
3
SBI MAGNUM MIDCAP FUND
16856.01
26
13
24
12
Sundaram Mid Cap Fund
10119.09
4
2
4
2
Tata Mid Cap Growth Fund
3348.4
3
2
3
2
Taurus Mid Cap Fund
115.62
1
1
1
1
Union Midcap Fund
1064.73
1
1
1
1
UTI - Mid Cap Fund
9824.84
5
3
5
3
WhiteOak Capital Mid Cap Fund
1658.05
1
1
1
1
*Pro-rata liquidation after removing bottom 20% of portfolio based on scrip liquidity (considering 10% PV with 3x volumes)
Through stress tests, investors gain clarity on the liquidity of their mutual fund assets. It also encourages mutual fund managers to maintain liquidity awareness and readiness for sudden redemptions.
Overall, these results underscore the importance of stress testing in providing investors with clarity on mutual fund liquidity. It also highlights the necessity for mutual fund managers to maintain liquidity awareness and readiness to meet sudden redemption demands effectively.