Overheated markets: Does the mid and small-cap mutual funds stress test reveal some unpleasant truths?

The latest stress test data revealed by the asset management companies (AMCs) in small and mid-cap mutual funds show that not much has changed in these categories since February this year.

The latest stress data for August revealed that it would take 19 days (Axis Small Cap) to 53 days (SBI Small Cap) to liquidate 50 per cent of their portfolio in case of a stress event.

The corresponding data for the first month of stress test (i.e., February) was 28 days and 60 days, respectively – not too far from the latest data.

The situation is not much different for mid-cap mutual funds. In August, the longest time it would take to liquidate 50 percent of the portfolio is anywhere between 8 days (Motilal Oswal Mid Cap) and 30 days (HDFC Mid-Cap Opportunities).

The corresponding data for the month of Feb stood at 10 days and 23 days, respectively – again not too different from the current data.

What is a stress test?

It is worth recalling that all mutual fund houses have been disclosing the results of stress test for their small and mid-cap schemes since March this year. This diktat had come from the capital markets regulator Sebi, which had directed all the fund houses to reveal the results of stress tests by the 15th of each month based on the preceding month’s data.

This data is shared on the website of AMFI (Association of Mutual Funds in India) every month. The practice was introduced in view of high valuation of small and mid-cap stocks. The first disclosure by mutual fund houses took place on March 15, while the latest being on Sept 15.

Small Cap Funds

(Source: AMFI; Disclosure of stress test for small cap funds)

Mid Cap funds

(Source: AMFI; Disclosure of stress test for mid cap funds)

Under this disclosure, fund houses are supposed to examine the liquidity of portfolio under stress scenarios for mid-cap and small-cap funds. Among other data points, the stress test reveals the number of days it would take to liquidate 25 per cent and 50 per cent of the portfolio in case of a stress event.

The fund houses are also supposed to reveal the proportion of assets these schemes have allocated to ‘cash’ to fulfil redemption requests. They are also meant to reveal a number of volatility metrics also such as benchmark annualised standard deviation (%) and portfolio beta.

At the end of August 2024, total assets under management of small cap schemes stood at ₹3.19 lakh crore, and that of mid cap schemes was ₹3.84 lakh crore.

The total AUM of large cap schemes was ₹3.68 lakh crore.