Stress tests by AMCs: Risk metrics of small, midcap funds in focus

MFs to release info on investor concentration & portfolio turnover ratio

Mutual funds (MFs) are poised to release their inaugural stress test reports later this week but this will necessitate additional disclosures. These will range from investor concentration to portfolio turnover ratio of smallcap and midcap funds.

According to a risk disclosure format that the Association of Mutual Funds in India (Amfi) has shared with fund houses, MFs will have to disclose total investment of the top 10 investors in two active schemes. They will also need to provide volatility metrics, such as the portfolio’s standard deviation and beta, which compares the portfolio’s volatility to a broader index.

The level of investor concentration can help determine whether the scheme corpus is held by a few investors or is well diversified. The portfolio turnover ratio, on the other hand, indicates the extent of stock churn undertaken by the fund manager.

In addition to the stress test report, MFs will need to disclose the trailing 12-month price-to-earnings ratio of the scheme and that of the benchmark.

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In January this year, Madhabi Puri Buch, chairperson of the Securities and Exchange Board of India (Sebi), had revealed that the markets regulator was in active discussion with the MF industry to do a comprehensive stress test of equity schemes and figure out measures to tackle situations when the test results indicate red flags. The stress test reports are set to be disclosed to the public for the first time on March 15.

These new disclosures form part of measures that Sebi has planned in a bid to shield smallcap and midcap fund investors amid increasing valuation risks. It has also asked MF trustees to establish an investor protection framework and suggested measures, such as limiting inflows and portfolio rebalancing.

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The format designed by Amfi also includes detailed guidelines for stress tests. MFs will need to specify the time required to liquidate 25 per cent and 50 per cent of the portfolio on a pro-rata basis. The test must be conducted excluding the 20 per cent of the portfolio that is most illiquid.

“While it is not mandatory for assets management companies (AMCs) to sell securities on pro-rata basis (i.e. sell securities in the same ratio as the portfolio composition), for the purpose of stress test it is assumed that a mutual fund scheme will sell the securities on a pro-rata basis to ensure equal treatment to all investors of the scheme,” Amfi said.

MFs have also been mandated to disclose the share of largecaps, midcaps, smallcaps, and cash in their smallcap and midcap funds.

Smallcap stocks have experienced a sharp rally in 2023-24, with the Nifty Smallcap 100 index seeing a monthly rise of over 4 per cent in nine of the first 10 months. However, these stocks have come under sustained pressure for the first time this financial year in March, amid regulatory scrutiny. The Nifty Smallcap 100 index has fallen by 5.5 per cent this month.

In the offing
 

Sebi's two-pronged approach to manage growing risks in smallcap and midcap funds:

Stress test & additional  disclosures
 

>MFs to release stress test reports of smallcap, midcap funds every 15 days; first reports on March 15

>They will disclose info on valuations, volatility indicators, and investor concentration

Investor protection measures
 

>Sebi asks MF trustees to suggest measures like limiting flows and rebalancing portfolios

> It tells them to ensure equal treatment of investors during phases of market turmoil