Mutual fund stress test: Methodology and test results for small and mid cap funds

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.