Are small cap mutual funds still risky? It would take THIS long to liquidate 50% portfolio, shows latest stress test

Around nine months after the stress tests for small and mid cap funds became mandatory for mutual fund houses, some of these funds would still require as long as 43 to 56 days to liquidate 50 percent of their portfolio in case of a stress event, reveals the latest data for October.

This is relevant because it indicates the time period (in days) it will take to liquidate 25 percent and 50 percent of the portfolio on a pro rata basis in case of a stress event. 

Delay in exiting the holdings of such stocks can lead to postponement in return of funds to investors at the time of redemption. Since mutual funds follow the T+2 settlement cycle, the redemption should happen in two days after the transaction.

Fund-specific liquidation timeframes

As the table below shows, DSP Small Cap Fund will take 43 days to liquidate 50 percent of its portfolio. The corresponding figure for February stood at 32 days. 

Meanwhile, Kotak Small Cap Fund will need 37 days and Nippon India Small Cap Fund will need 31 days to liquidate 50 percent of its portfolio.

It is worth noting that while calculating the time taken to liquidate a portfolio on a pro-rata basis, the 20 percent of least liquid securities of the portfolio are ignored.

(Source: AMFI)

It is worth remembering that all mutual fund houses are required to disclose the results of stress tests for small and mid cap schemes by the 15th of every month based on previous month's data. This was meant to enhance transparency and provide investors with more insight into the risk profiles of such schemes.

Besides, the disclosure does not only require the liquidation time period to be revealed. It also includes the annualised standard deviation for the scheme portfolio and benchmark index.

Additionally, the disclosure also includes the portfolio's trailing 12-month PE for scheme portfolio and benchmark index. The disclosure also includes the portfolio's trailing 12-month PE for both the scheme portfolio and scheme benchmark index. One more metric is the portfolio beta which provides insight into the scheme's risk relative to the overall market.

(Source: AMFI)

When seen from the lens of liquidating 25 percent of the portfolio, Axis Small Cap Fund will require 10 days on a pro rata basis in case of a stress event. Nine months ago, the corresponding figure was 14 days. 

Quant Small Cap Fund and SBI Small Cap fund would require 28 days to liquidate 25 percent of portfolio against 11 days and 30 days, respectively in February.