Market regulator Sebi to release stress test findings on equity MFs

The Securities and Exchange Board of India (Sebi) will soon publish the results of an industry-wide stress test conducted on equity mutual funds (MFs). The test assessed the number of days required to meet large redemptions over a short period. Sebi's whole-time member Ananth Narayan indicated that the preliminary findings were encouraging, but included some caveats.

Narayan, while addressing a conference organised by Café Mutual, said that despite a substantial increase in mutual fund holdings of stocks, the number of days needed to cater to a hypothetical 10-20 per cent sudden redemption had not significantly changed between March 2020 and March 2024.

He had earlier urged the industry to proactively conduct such stress tests themselves for risk management. 

Fund houses have started publishing their own stress test results for smallcap schemes every fortnight since March, amid concerns of "frothy valuations."

Sebi had called for these tests due to strong inflows into smallcap and midcap funds, despite high valuation concerns. The test is aimed at keeping the investors better informed.

Narayan questioned the secondary market's ability to absorb MF sales during a stress period, given their willingness to buy during good times. He noted that MFs, domestic institutional investors, and individuals have increased their holdings in midcap and smallcap companies from 54.3 per cent to 60.6 per cent of the free float between March 2020 and March 2024.

The stress test calculates the number of days required to liquidate assets based on recent trading volumes. The test, designed by the Association of Mutual Funds in India (Amfi), includes conditions like pro-rata liquidation after removing the 20 per cent least liquid holdings.