What is Sebi stress test and why Quant MF will take 22 days for 50% small-cap liquidation

Sebi did a stress test on small-cap funds, basically checking how fast they could return investors' money if there was a sudden rush of withdrawals. Different funds performed differently

Imagine you invest in a piggy bank called "Small Cap Fund", which holds a bunch of coins(representing small companies). Now, market regulator Sebi wants to ensure this piggy bank is healthy. So, they conducted a stress test. Imagine shaking the piggy bank hard to see if any coins (investments) fall out easily.

The test checks two things:

Selling Speed: How quickly can the fund manager sell some of the coins (small company stocks) if many investors suddenly want their money back (redeem their investments)?

Price impact: Will selling those coins quickly bring down their price significantly (affect the fund's value)?

By testing this, SEBI aims to:

Protect Investors: Ensure your small cap fund has enough "easily sellable" coins (liquid investments) to handle unexpected redemptions.

Keep Funds Prepared: Motivate fund managers to be mindful of liquidity and have a plan for selling assets if required

Why only small caps?

 Small company stocks can be harder to sell quickly than large companies. So, Sebi is checking if the fund managers could sell enough stocks fast enough to meet everyone's redemption requests.

The Result: Each fund has now disclosed how long it would take to sell 25% and 50% of their holdings. This gives investors an idea of how easily they can get their money back from the fund.

Quant Mutual Fund was one of the first to reveal their results from the SEBI stress test! Here's what they said in a nutshell:

They tested their piggy banks: Quant shook their small-cap and mid-cap fund piggy banks (their investment portfolios) to see how long it would take to get money out.

The results:

1. Their Quant Mid-Cap Fund could return your money in six days if you needed to sell out half (50%) of the fund. It would take 3 days to get 25% back.
2. Their Quant Small-Cap Fund would take longer. It might take 22 days to return your money if you want to sell out half, and 11 days for 25%.

Why will small caps take longer?

 Smaller companies (small-cap) can be trickier to sell quickly compared to bigger companies (mid-cap). So, it takes a bit longer to get your money back from the small-cap fund.

Unlike big companies that everyone wants, some small company stocks might be less well-known or have fewer interested buyers. It might take longer to find someone willing to buy these stocks at a decent price. Moreover, selling in bulk can be tricky.

Market Cap & Top-10 Investors Concentration: Holdings of large, mid, small cap stocks and cash are 27.36%, 69.57%, 0% and 3.07% respectively, in the quant Mid Cap Fund and 28.36%, 0.24%, 65.87% and 5.53% respectively, in the quant Small Cap Fund. Top-10 investors hold only 2.99% in the quant Mid Cap Fund and only 2.10% in the quant Small Cap Fund.

What did Edelweiss MF say? 

Edelweiss MF said their small-cap fund could be liquidated rather quickly. It would take three days to sell out 50 per cent of the fund's holdings and just two days to sell 25 per cent.

What did Nippon MF say 

Nippon India Mutual Fund (MF), which reportedly manages the largest SmalCap fund with AUM of Rs 46,044 crore, in its first stress test report of SmallCap and MidCap scheme said that it would require up to 27 days to liquidate 50 per cent of the SmallCap fund portfolio and 13 days to offload 25 per cent of the assets. 

This stress test is like a practice run to see how well the fund can handle many investors asking for their money back at once.