Stress test: Top 6 smallcap funds need over 20 days to liquidate 50% assets

The country’s six largest smallcap schemes would require more than 20 days to liquidate half of their holdings, despite most of them maintaining high cash levels and having considerable exposure to more liquid largecap stocks, stress tests conducted by fund houses reveal.

For midcap funds, the time required to sell half of the assets of the top six schemes varies between seven and 34 days, according to disclosures made by asset management companies.

The Securities and Exchange Board of India (Sebi) had called for such tests in the face of strong inflows into smallcap and midcap funds, despite concerns over high valuations, to keep investors better informed.

 

SBI MF, which manages the third-largest smallcap scheme with a corpus of Rs 25,500 crore, estimates it would need 60 days to sell half of the assets of the fund and 12 days to liquidate a quarter of it. However, the fund house is confident that the scheme can handle a surge in redemptions, if any.

“Our smallcap fund is well placed to face any difficulties that might emerge. The portfolio has top-quality stocks, along with significant cash holding and exposure to largecap stocks. In addition, a portion of the portfolio is hedged and there is a constant flow of money through the SIP (systematic investment plan) route,” said D P Singh, deputy MD and joint CEO of SBI MF.

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The stress test calculates the number of days required to liquidate assets based on recent trading volumes in the underlying stocks. The format, designed by the Association of Mutual Funds in India (Amfi), also sets other specific conditions such as adopting a pro-rata basis of liquidation after removing the 20 per cent least liquid holdings.

For the test, MFs have to assume a 10 per cent participation volume and three times the average daily volumes seen in the past three months for each of the stocks in the portfolio. Besides SBI MF, HDFC, Tata, Kotak, and DSP will need over 30 days to sell 50 per cent of their smallcap fund portfolios. Tata and DSP manage their smallcap funds with a “true-to-the-label” strategy as they invest nearly 90 per cent of the corpus in smallcap stocks vis-a-vis 65-80 per cent allocation in the case of other large schemes.

Nippon India MF’s smallcap schemes, which is the largest in the category with an AUM of Rs 46,000 crore, has said it will need 27 days to liquidate half of the portfolio. 

Schemes with smaller assets under management (AUM) are seen to be comfortably placed in terms of liquidity in the stress test. All the schemes having less than Rs 5,000 crore AUM have said that 50 per cent of the assets can be sold within five days.

While the test results have given some indication to investors about the liquidity risk while investing in small-cap schemes, they still may not be a good indicator of identifying the stress that funds may face in real time.

“There is no scientific basis for it. It assumes liquidity to be a constant at best and extrapolates the past into the future at worst. If liquidity actually vanishes in a particular stock, it can just vanish not in 6 days or 14 days or whatever other metric is used - it will vanish in a microsecond. Analysis by extrapolation may or may not work. Yes, liquidity is often higher with higher volatility - but it's not a given,” said Sandeep Parekh, founder of Finsec Law Advisors, in a social media post.