Mutual funds' stress tests FAQ: Process, investor guidance and key details

The decision to undertake stress test was taken earlier this month following discussions between SEBI and mutual fund body AMFI.

Small and midcap funds have been drawing the lions share of retail inflows through the last several months, far more than the money coming in largecap funds.

The market regulator is concerned about the ‘over exuberance’ and ‘froth’ building up in some pockets of the broader market.

SEBI Chairman has said that valuations of some stocks in mid and smallcap segment seem to have ‘gone off the charts’.

The stress tests are aimed at finding out if small and midcap funds can meet redemption requests in an orderly manner in the event of a market fall or heightened volatility.

Mid and small cap funds will test redemption processing ability in the event of market stress.

‘Stress’ situation is the one where only 10% ‘market participation’ is available to MF schemes.

In this situation, trading volumes are 3x the normal.

Stress tests will not take into account the top most-illiquid stocks accounting for 20% of portfolio weight.

Stress tests must show the number of days it will take a fund to liquidate 25% and 50% of portfolio.

This exercise is to be conducted every month.

Results of the first round (for month of February) will be out on March 15.

Experts say the result of stress tests should not be seen in isolation and investors must not panic.

Mutual funds will soon start disclosing more data around mid and smallcap funds including average portfolio valuation, portfolio volatility which is measured through parameters like standard deviation and portfolio beta.

A wholistic view must be taken and investors are advised to keep their portfolios well balanced across large, mid and smallcap funds in sync with their risk appetite.