Today we will discuss the recent “Stress Test” that SEBI asked to do in Mutual funds

When you pay money to a mutual fund AMC, they have to invest in equity or debt according to the goals set. Let us discuss the small and midcap equity funds in specific as the stress tests were ordered for them.

SEBI felt the inflow into small caps and midcaps looked like a froth (a stage just before the bubble) and wanted to ensure that the investor’s money was safe and sound.

The stress test is a measure of liquidity, i.e. the time taken by the AMC to redeem 25% and 50% of its funds.

Let us assume that all the buyers of an SBI small-cap fund wish to withdraw 50% of their investments at the same time. As per the table, it would take 60 days for the AMC to give the money back to its investors.

The higher the time taken, the more worried the investors should be. If the funds are having a huge redemption pressure, panic will spread and most likely the assets (stocks) will see further selling.

When the stocks drop in value, the selling pressure will accelerate. Firstly, due to the index fund criteria, and secondly, no buyers will be ready to buy due to the panic. The bid/ask spread will go up and the asset will most likely be in a free fall.

India has never witnessed a strong bear market that runs for years. This is mostly because investors worldwide believe the growth story of India is safe and intact.

Bear market is a killer of investments and I strongly think a similar stress test has to be done for the investors too. What will happen if your portfolio dips by 20%, 30%, or 50% ??