NEW DELHI: With growing concern over massive inflows into mid- and small-cap funds, the Securities and Exchange Board of India (SEBI) asked the mutual funds to do a stress test on these schemes.
The stress test exercise was necessarily made to be done by the mutual funds to see if they face large redemptions pressure, how long will they take to pay the money to their investors. The mutual fund houses have reiterated that the stress test is not new, and that they have been doing it internally without making it public. Some industry insiders have blamed the Sebi diktat to make the stress test result public for creating panic in the market.
A tell-all exercise
The stress test ordered by the Sebi and which is available for all investors to see on the website of Association of Mutual Funds in India (AMFI) turned out to be much more than just disclosure of the fact how long the small and mid-cap schemes would take to liquidate all their holdings. The stress test results show -- in 16 columns -- how the funds have performed on five broader categories namely asset under management, time to liquidate the portfolio, market-cap concentration, volatility and valuation.
The stress test that the Sebi has ordered is basically the time taken by mid and small-cap funds under stress condition to liquidate 50% and 25% of their portfolio respectively on a pro-rata basis (i.e. sell securities in the same ratio as the portfolio composition). While calculating the time taken to liquidate portfolio on pro-rata basis, the 20% of least liquid securities of the portfolio are ignored.
Though it is not mandatory for AMCs to sell securities on pro-rata basis, for the purpose of stress test it is assumed that the mutual fund scheme will sell the securities on pro-rata basis to ensure equal treatment to all investors of the scheme. Other details which have been submitted by the fund houses include asset under management (AUM) of these schemes, valuation of the portfolio vis-a-vis the benchmark, volatility measured in standard deviation and beta, concentration of small-, mid- and large-cap equities in the portfolio. The data also shows how frequently the portfolio is tweaked by the fund manager.
Stress test result
So, what does the stress test result show. How liquid is the small and mid-cap mutual fund scheme where you are investing your money in.
Among the mid-cap funds, HDFC Midcap Opportunities Fund is the largest asset with over R60,000 crore assets. The fund would take 12 days to liquidate 25% of the portfolio, while 23 days to liquidate or sell 50% of the equities it holds in its portfolio. This is one of the most illiquid funds in its category after Kotak Emerging Equity Fund. HDFC Midcap Opportunities Fund invests 80% of the money in mid- and small-cap equities, 13% in large-cap and maintains 7% cash. In terms of valuation, the HDFC Midcap Opportunities Fund portfolio shows a 12-month trailing price-to-earnings (PE) ratio of 23 compared with the benchmark PE of 27.
Across all mid-cap funds, schemes may take less than a day to 34 days to liquidate 50% of their portfolio. Of the 26 mid-cap funds, only six are taking 10 or more days to liquidate 50% of their portfolio.
Among the small-cap funds, SBI Small-cap Fund has the most illiquid portfolio as it would take 60 days to sell off 50% of the equities it is holding in its portfolio. It would take 30 days to sell-off 25% of the portfolio. SBI Small-Cap fund has an asset size of R25,500 crore, one of the larger funds in asset size in the category. The second most illiquid fund is HDFC Small Cap Fund, which has R 28,600 assets under management. The fund would take 42 days to liquidate 50% of its portfolio and 21 days to liquidate 25% of its portfolio.
Across the category, small-cap funds take anywhere from one day to 60 days to liquidate 50% of the stocks in the portfolio. Most small-cap funds hold from 65%-95% of the portfolio in small-cap equities.
Why illiquidity
Not all but some funds may have to buy small or mid-cap stocks that are not traded with large volume on the exchanges. Some mutual fund schemes may have very high inflows and in order to stick to the fund mandate, they may be forced to buy small-cap or mid-cap stocks with poor liquidity.
Investors should not get too panicked about the stress test diktat of the Sebi, and take any steps in haste. They should instead take lesson from this, and build a ‘healthy’ portfolio. Investors investing in mutual funds should not have a concentrated exposure to mid and small-cap funds. The core portfolio of an investor should have large- and flexi-cap funds. Mid- and small-cap funds should not go beyond 30-35% of the portfolio.