The evolution of the financial markets in India also maps a path of increasing investor protection. Stress tests are conducted in mutual funds to increase transparency and protect investors from sudden shocks in times of turmoil.
Under the direction of market regulator SEBI (Securities and Exchange Board of India), the Association of Mutual Funds in India (AMFI) has instructed AMCs to make public stress test results once every fortnight.
Central concept
The central concept of stress tests in a mutual fund is trying to find out what will the fund manager will do if he/she faces a situation akin to a run on a bank, which is a huge number of depositors scrambling to take their money out from the bank simultaneously.
Imagine a very large number of investors with a fund eager to redeem their holdings as soon as possible. Under such unenviable circumstances, how quickly can a fund manager redeem the portfolios of investors who are seeking to do so is the key parameter to find out.
Hypothetical scenario
Hypothetical scenarios are created and calculations are done to determine how the fund would behave under such situations.
Say pro-rata liquidation of 25% or 50% of a fund takes place. It is calculated how quickly can the fund manager comply with the redemption requests.
On its website, AMFI publishes the outcomes of these stress tests.
Small cap fund outcomes
Take a sample from the month of May this year. If 25% of the fund is redeemed, the managers of some of the popular funds would take the following number of days to comply with the redemption requests: Bank of India Small Cap Fund, Baroda BNP Paribas Small Cap Fund, ITI Small Cap Fund, LIC MF Small Cap Fund, PGIM India Small Cap Fund Quantum Small Cap Fund and Union Small Cap Fund would take just 1 day.
On the other hand, HDFC Small Cap Fund would take 36 days to redeem 25% of the units. This is the longest period.
Of the 27 small cap funds in the stress test list, 18 funds will take less than or equal to seven days to liquidate 25% of the units.
If the pressure on the fund is to redeem 50% of the units, the time top comply goes up.
Only 14 funds can handle 50% redemption requests within a week.
HDFC Small Cap Fund would take the longest 71 days to liquidate half the portfolio. Only Quantum and LIC Small Cap Fund would be able to comply with 50% redemption request within just 1 day.
Mid cap results
In the mid cap fund segment, the liquidity is higher and, therefore, the requests can be handled faster. Of the 29 funds, as many as 9 funds can handle requests for both 25% and 50% redemption in just 1 day flat.
The longest time to redeem 50% is 26 days and would be taken by HDFC Mid-Cap Opportunities Fund.
The first stress test results were announced in the middle of March 2024 after SEBI said “froth” was gathering in certain pockets of the market after concerns of stretched valuations were expressed by a large section of experts.
AMFI says that 20% of the least liquid securities of the portfolio of any fund are ignored while calculating the time taken to liquidate portfolio on pro-rata basis.
Mutual Funds Stress tests: The first stress results were made public in mid-March. These are now conducted once in 15 days. Personal Finance Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
