All Asset Management companies (AMCs) are mandated by Securities & Exchanges Board of India (Sebi) to conduct stress tests on small and mid cap funds on the 15th of each month starting from March 15, 2024.
After Sebi sensed that mid-cap and small-cap stocks may have been overvalued, it directed mutual fund industry body Association of Mutual Funds of India (AMFI) to inform AMCs to conduct the stress tests. To assess mutual funds' claim of instant liquidity, the stress test evaluates the liquidity of a portfolio by calculating the time required to sell off 25 per cent and 50 per cent of its holdings. More specifically, the time needed to liquidate 80 per cent of the most liquid assets is only calculated, excluding the least liquid 20 per cent of the portfolio from the assessment. Thus investors can see how soon they can get their money back if the equity markets were to collapse and there is a rush to redeem.
AMFI Ask AMCs To Display These Metrics; How Investors Can Use Them?
In addition to stress testing, AMFI has outlined the following three metrics that AMCs must display on their website in simple language easily understandable by investors. But irrespective of the mutual fund category, these metrics can be of much help to investors in gauging their investments effectively. These metrics are:
Annualised Standard Deviation: AMFI asked AMCs to measure both standard deviation concerning the scheme portfolio and scheme benchmark index. The Annualized Standard Deviation in a mutual fund scheme's portfolio and its benchmark index shows the degree of volatility or fluctuations over a specified period. Here it will be a deviation from the average return of the scheme portfolio and the benchmark index in one year. A higher standard deviation indicates higher risk.
Portfolio Beta: This metric measures how sensitive a mutual fund's portfolio returns are to movements in the broader market. A beta of 1 indicates that the fund's returns move in line with the market, while a beta greater than 1 suggests the fund is more volatile than the market. A beta less than 1 is more suitable. For instance, Fund A has a beta of 0.95, which means if the Nifty 500 falls by 1 per cent, then Fund A is expected to fall by 0.95 per cent.
Portfolio trailing 12-month PE: For all stocks held within the mutual fund's portfolio, the value of stocks is calculated by dividing the current market price of the portfolio's holdings by the trailing 12-month earnings per share (EPS) of those holdings. A higher PE ratio shows that portfolios are expensive compared to their earnings, suggesting that they are overvalued and thus risky.
Why Stress Tests Now?
AMFI and the Securities and Exchange Board of India feel that huge recent returns provided by small and mid-caps resulted in people overvaluing these stocks and investing in them without assessing fundamentals. Even after AMFI signalled caution the inflow into small mid-cap funds continued unabated. In February's AMFI monthly data released today, Small-cap funds took the lead in terms of inflow with a net inflow of Rs 2,922.4 crore, followed by mid-cap funds with Rs 1,808.2 crore.
