Stress levels of over 40% of small-cap MF schemes higher than February amid steady inflows

The stress levels of 12 out of 28 small-cap mutual fund schemes were higher in October compared to February when the Association of Mutual Funds in India started disclosing the results of the stress test on these schemes.

This comes even as investors continue to bet big on small-cap funds and capitalise on the decline in market valuation to pump in more funds.

The inflows in small-cap funds rose by 23 per cent last month to ₹3,771 crore, compared to ₹3,071 crore in September. The inflows in the September quarter were higher at ₹8,389 crore, against ₹7,197 crore recorded in the June quarter.

Capital market regulator SEBI directed mutual funds to conduct the stress test starting February this year, amid concern over huge fund flows into these schemes despite fear of frothy valuations.

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The stress level is gauged on the days taken to offload 50 per cent of the investment after removing the bottom 20 per cent of the small-cap fund portfolio, besides concentration and volatility risks.

Longer duration

Analysis done by businessline shows that the number of days for Quant and DSP Small Cap funds to offload 50 per cent of its portfolio were higher, at 55 and 43 days in October, compared to 22 days and 32 days logged in February.

The increase in the number of days comes as the AUM of Quant and DSP small cap AUM funds surged by 53 per cent and 18 per cent to ₹26,331 crore and ₹16,148 crore last month, compared to ₹17,233 crore and ₹13,703 crore in February.

Among large fund houses, SBI Small Cap and Tata Small Cap have reported a shorter number of days to liquidate half of their portfolio at 56 and 27 days compared to 60 and 35 days registered in February. Both fund houses have restricted investments in their small-cap funds.

Anil Rego, Founder and Fund Manager at Right Horizons PMS said even as established fund houses restricted inflows, there has been heightened investor interest in the small-cap segment due to expectation of high growth potential and the broader rally in equity markets that were observed in the last 2-3 years.

The stretched valuations in broader markets and slowdown in profits of small and mid-cap stocks (ex-BFSI) may induce further fall especially if triggered by macro events, he added.

Anirudh Garg, Partner and Fund Manager, Invasset PMS said, “Stress levels in the small-cap space persist due to the sudden crash in this segment in last two months.”

Small-cap stocks are inherently less liquid, and when large funds attempt to offload positions, it often causes significant price distortions, he added.

With large fund houses restricting inflows to safeguard liquidity and avoid excessive portfolio concentration, retail and institutional investors are turning to new fund offers in the small-cap space, he said.

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Sahil Shah, Managing Director and CIO, Equirus said price correction in last two months were high due to FII selling largely in large caps.

“If there is a major correction beyond the current level then liquidity can dry up as we have seen in previous cycles,” he said.

Manish Bhandari, founder and CEO, Vallum Capital Advisors said investors in small and mid-cap funds should know that they are carrying liquidity and higher volatility risk in such portfolios or stocks.

However, he said the future of mid and small caps are bright as most of them are growing 1.5 times higher than the large-cap counterpart and the PMS industry has done well in select stock picking in this space, he said.