How would you know whether a small cap mutual fund is safe to invest in terms of future volatility? Among several metrics, you may also consider the results of ‘stress test’ which each mutual fund is supposed to reveal every month.
A small cap mutual fund invests a minimum of 65 percent of total assets in small cap stocks, per the Sebi’s categorisation of mutual fund schemes. This means a minimum of 65 percent of assets are invested in small cap stocks which are not as liquid as their larger counterparts.
Small cap funds are typically quite volatile in nature but are seen to have a higher upside than their larger counterparts. As a result these funds drew considerable investment of retail investors in the past few years, leading to spike in their valuations.
So, if you are still interested in investing in small cap funds, it is recommended to assess the stress test beforehand.
The latest stress data shows that it would take up to 36 days (maximum) to liquidate 25 percent of portfolio of small cap mutual fund or schemes.
The corresponding data for Axis Small Cap Fund is 12 days, for DSP small Cap Fund it is 25 days and for HDFC small cap fund, it is 29 days, and the maximum time-period is 36 days for Quant Small Cap fund.
As far as 50 percent of portfolio is concerned, it would take upto 73 days for liquidation of portfolio in a stressful situation. While it would take Axis Small Cap fund 25 days to liquidate 50 percent of portfolio during stressful situation, Quant Small Cap Fund would require 73 days. Small Cap Fund would take 62 and Tata Small Cap Fund would require 32 days, as the table below shows.
(Source: AMFI; data belongs to Dec 2024)
(The stress test results show number of days required to liquidate 50% and 25% of the portfolio on a pro-rata basis, under stress condition).
What is a stress test?
For the unversed, all mutual fund houses are supposed to disclose the results of stress test for their small and mid-cap schemes since March 2024.
This order had come from the capital markets regulator Sebi, which directed all the asset management companies to reveal the results of stress tests by the 15th of each month based on the previous month’s data.
This data is meant to be shared on the website of AMFI (Association of Mutual Funds in India) every month. This was a step taken in view of spike in valuation of small and mid-cap stocks. The first disclosure happened on March 15, while the latest being on Jan 15 for te month of Dec 2024 as listed below.