AMFI calls for stress test on mid, small-cap schemes

The Association of Mutual Funds in India (AMFI) has asked fund houses to conduct stress test on their mid- and small-cap schemes based on last month data and disclose the findings before March 15. The move comes on the back of market regulator SEBI’s concern over froth in these schemes amid relentless flow despite large fund houses restricting inflows due to lack of investment opportunity at right valuation.

In a bid to instil investors’ confidence and transparency, both SEBI and AMFI have directed fund houses to conduct regular monthly stress test on these schemes and make proper disclosure to investors.

AMFI and asset management companies will display the stress result of these schemes on their websites within 15 days after the end of each month. The stress test reporting will begin from March 15 after analysing the February month data.

Despite the industry efforts, mid- and small-cap funds have been attracting investment and this stress test will enlighten investors on the risk they are taking with their exposure to these schemes, said a CEO of leading fund house.

Too much of cautioning will also send a wrong signal and may lead to investors doubting the capability of other equity schemes, he added.

Focus area

The stress test will mainly focus on the ability of the fund house to face redemption pressure in these schemes and detect whether any large investors are skimming profit by taking advantage of investor frenzy in these schemes.

The stress test will focus on liquidity of the mid- and small-cap schemes portfolio and ascertain the time frame taken to sell 50 per cent and 25 per cent of the portfolio without eroding the gains accrued.

Typically, mid and small-cap stocks are low on liquidity and any large investments or sell-off take weeks to be executed. This has resulted in mutual funds chasing the same set of liquid small cap stocks and pushing up their valuations multi-fold.

Mutual funds will also give additional details on mid- and small-cap equity schemes’ price-earnings ratio compared to their respective benchmark indices. Besides highlighting the valuation of the scheme compared to their benchmark indices, a higher deviation indicates the kind of risk the investor will be taking by investing in these funds.

The stress test will also make disclosure on the portfolio turnover that will shed light on the churn of stocks undertaken by the fund manager. Besides booking profit, higher churn of portfolio usually indicates the quantum of unconvincing investment call taken by the fund manager and this also adds up to the overall cost.

AUM of small-cap funds

The overall, asset under management of small-cap funds has increased 89 per cent to ₹2.48-lakh crore in January against ₹1.31-lakh crore registered in the same period last year while that of mid-cap was up 58 per cent at ₹2.90-lakh crore (₹1.83-lakh crore) in the same period, according to the AMFI data.

Last year, the Nifty Midcap 150 index gave a return of 45 per cent while Nifty Smallcap 250 index was up 49 per cent. Small-cap MF schemes on average delivered return of 41 per cent and that of mid-cap funds was 37 per cent. Lured by returns, investors flocked to invest in these schemes unmindful of the underlying risks and this has led to SEBI concern.