All eyes are on mutual fund stress test No. 2; here's what to expect

The next round of results is expected by April 15.

Asset management companies (AMCs) are about to announce the next round of results of a stress test on small-cap and mid-cap funds. Industry experts believe that the fund houses will disclose data that is largely similar to the first round, with some minor changes.

In the first round of results, announced around March 15, mid-cap funds would typically take approximately six days to liquidate half of their portfolios, while small-cap funds would take an average of around 14 days to do the same.

As mandated by the Securities and Exchange Board of India (SEBI), AMCs have to disclose the results of the stress test and liquidity, volatility, valuation and portfolio turnover in respect of mid-cap and small-cap equity schemes within 15 days of the end of each month. The next round of results is expected by April 15.

Stress test results have gained significance as small-cap funds saw outflows for the first time in 30 months in March after the capital markets regulator highlighted concerns over “froth” in the smaller-cap segments.

Minor tweaks

According to experts, it is natural for large small-cap funds to take longer to liquidate their portfolios during market corrections.

As per the last data, Nippon India Small Cap Fund, the largest in the category, would take 27 days to liquidate 50 percent of its portfolio. It would take HDFC Small Cap Fund, the second biggest scheme, 42 days to do the same, and SBI Small Cap Fund, the third largest in the category, 60 days to sell half of its portfolio.

As per Nirav Karkera, Head of Research at Fisdom, there was limited time for fund managers to adjust their portfolios to show better numbers in the first-ever stress-test result.

“Since the results are now going to be a regular affair, expect fund managers to be more conscious of their liquidity positions. Fund houses may also try and align their portfolios in favour of more liquid stocks so that they offer significantly higher comfort to small-cap and mid-cap investors,” he said.

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ICICI Mutual Fund, which manages a Rs 7,173-crore small-cap fund, sees minor tweaks in the fund.

“In our small-cap fund, over the past several months, we were at the lower band of allocation when it comes to small-caps. This was due to our belief that there was significant froth building up in this space. So, as of March 31, the allocation to large-caps and mid-caps in the scheme stands at 8 percent and 17 percent, respectively,” said Anish Tawakley, Deputy Chief Investment Officer-Equity, ICICI Prudential Asset Management. “The only major change we have made over the past month is that we have slightly trimmed the mid-cap exposure.”

Keeping vigil

Some of the funds Moneycontrol spoke to are constantly looking to manage risks in the small-cap space.

Bandhan Mutual Fund is among the fund houses that were comfortable in terms of their liquidity positions. The last stress test results showed that Bandhan Small Cap Fund (AUM of Rs 4,385 crore) would take just three days to liquidate 50 percent of its portfolio.

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As per Sirshendu Basu, Head-Products, Bandhan AMC, the fund house continues to operate the way it did before the stress-test results.

“We have a portfolio that has more stocks. Currently, we have about 135 stocks in the small-cap fund, so that individual stock exposure is limited. Depending upon the market situation and regular profit booking, there is cash in the books, as well. We feel that these two measures are reasonable to have higher liquidity in a portfolio,” Basu said.

Comfortable position

Smaller-sized small-cap funds have the benefit of being more agile and nimble, having the ability to manoeuvre their portfolios without much risk of liquidity or impact costs.

In the last stress test, Edelweiss Small Cap Fund, which has assets under management of Rs 3,135 crore, showed that it would take just three days to liquidate 50 percent of its portfolio.

“We have liquidity measures well built in our process at the portfolio construction stage. Hence, we scored relatively quite well in the stress test in our mid-cap as well as small-cap strategies,” said Trideep Bhattacharya, CIO-Equities, Edelweiss MF.

Chirag Mehta, CIO, Quantum MF, also expects no changes in strategy in the Quantum Small Cap Fund based on the stress-test results.

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“We were not needed to do anything, because we have already built in criteria on liquidity and market capitalisation during the conceptualising stage. So, liquidity was never a worry for us in our portfolio,” said Mehta. “It's not just that the fund size is small, and therefore tweaks are not required; even at a scale, we wouldn't have to worry about liquidity trades until and unless we don't reach the capacity thresholds.”