Major small-cap funds increase exposure due to MF stress test: Know more here
A stress test assesses the duration required for an investor to regain their investment in case of an equity market downturn and a subsequent increase in investor redemptions.
There's a new term gaining traction in the markets: Stress tests. Recent attention has been focused on how funds are adapting to the need for enhanced liquidity management with new additions to their portfolios. Before understanding the strategy, it's essential to grasp the concept of stress tests and how it functions.
To begin with the basics, what exactly is a stress test?
A stress test assesses the duration required for an investor to regain their investment in case of an equity market downturn and a subsequent increase in investor redemptions. Mutual fund companies utilize these tests to evaluate the liquidity of small and midcap portfolios.
During the test, fund managers determine how swiftly they can sell small and mid-company stocks if numerous investors request redemption of their units. Additionally, the test evaluates the potential price impact of selling these stocks, assessing whether it would significantly reduce their prices or not.
What prompted SEBI to ask fund houses to conduct this test?
SEBI is concerned about the potential overheating of these funds and aims to verify the capability of Small-Cap funds to manage unforeseen redemption requests. SEBI's objective is to guarantee that fund houses possess adequate liquidity and a strategy for selling stocks if necessary.
In response, the Association of Mutual Funds in India (AMFI) instructed asset management companies (AMCs) to conduct stress tests on their schemes using data from the previous month and disclose the results before March 15. Subsequently, these numbers must be disclosed every 15 days.
Recent strategies to enhance liquidity
The disclosure indicates that funds with larger asset sizes may require more time to liquidate their portfolios compared to smaller-sized funds. Surprisingly, within the larger small-cap funds, some have reported shorter days to liquidate their portfolios.
Although the liquidity disclosure requirement is not expected to affect the portfolio construction of Mid-Cap and small-cap funds, fund managers may consider increasing holdings in stocks with higher liquidity to enhance competitiveness within the category. Looking ahead, any new additions to the portfolio will likely require improved liquidity management.
In March, larger asset-sized small-cap funds significantly increased their exposure to specific stocks. Notably, the Nippon India Small Cap Fund, with a corpus of Rs 45,749 crore, made new investments in Aster DM Healthcare Limited, VIP Industries Limited, and Galaxy Surfactants Limited. Similarly, the HDFC Small Cap Fund, with a corpus of Rs 27,574 crore, added new holdings such as Blue Dart Express Limited, Cyient Limited, and Zensar Technologies Limited during the same period.
As investors, why should we pay attention to stress tests and how do they benefit us?
Stress tests offer investors valuable insights into how their mutual fund investments may fare during challenging market conditions. By grasping the potential risks and weaknesses in the fund's portfolio, investors can make more educated decisions and adjust their expectations concerning potential losses during market downturns.
Moreover, stress tests help determine whether the stocks in your fund are overvalued or still deemed reasonable. These tests compare the benchmark index's price-earnings (PE) ratio against your portfolio, providing crucial information for investment decision-making.
Disclaimer: The article is for informational purposes only and not investment advice.