Sebi has urged the country’s asset managers to provide investors with more comprehensive information regarding the risks associated with small and mid-cap funds, as per insights from a fund manager and two sources familiar with the situation.
The significant inflows into small and mid-sized funds have raised concerns among authorities about their resilience in the event of a sharp market downturn. Sources have indicated that the Securities & Exchange Board of India (SEBI) is scrutinizing stress tests conducted by these funds.
These funds are now required to disclose details such as the potential timeframe to accommodate substantial redemptions, the potential impact of significant outflows on portfolio value, and the amount of cash and liquid assets held to meet potential outflows, according to the sources.
Harsha Upadhyaya, chief investment officer at Kotak Mutual Fund, stated, “Investment committees were always aware of liquidity challenges but investors were not. Once this information is available to them, they can compare each fund.”
The Association of Mutual Funds in India (AMFI), in collaboration with SEBI, is proposing a standardized format for risk disclosure, with plans for regular disclosures.
Sebi and AMFI have not immediately responded to requests for comments.
The substantial inflows have led to a 71% surge in the Nifty Small Cap 250 index and a 64% increase in the Nifty Mid Cap 100 index over the past 52 weeks, surpassing the benchmark Nifty’s 28% rise.
According to one source, funds are expected to commence making these disclosures from April.
Mutual funds typically maintain between 1% and 5% of their assets as cash to handle outflows, although there is no minimum regulatory requirement.
To be classified as a small-cap fund, funds must invest at least 65% of their assets in small-cap stocks, with the remaining 35% potentially invested in cash or large-cap stocks. The same rule applies to mid-cap funds.
“In some cases, the funds do not have enough cash. While in others, funds are fully invested in small/midcap stocks with no prudent investments in large-cap stocks,” added the second source.
In India, small-cap stocks are those with market caps below 50 billion rupees, while mid-cap stocks have market values between 50 billion and 200 billion rupees.
Kotak, which manages a 144 billion rupee ($1.7 billion) small-cap fund, has imposed temporary restrictions on inflows, citing concerns that “momentum chasing” is overshadowing the necessary caution. Last year, Tata Mutual Fund and Nippon India Mutual Fund halted lump sum investments in their small-cap funds.