SEBI mutual fund stress testing framework of 2024

The SEBI mutual fund stress testing framework of 2024 is the regulatory framework introduced through SEBI Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14 dated 27 February 2024 that requires asset management companies (AMCs) managing small-cap and mid-cap mutual fund schemes to conduct monthly portfolio-liquidity stress tests and publicly disclose the estimated number of business days required to liquidate 25 per cent and 50 per cent of their small-cap and mid-cap portfolios under prevailing market conditions. The framework was SEBI’s policy response to the substantial inflows into small-cap and mid-cap funds during 2022 to 2023, which had produced concerns about liquidity mismatch between the open-ended scheme structure and the underlying market-cap segment’s daily trading liquidity. The framework is anchored in the SEBI (Mutual Funds) Regulations, 1996 and is administered by the SEBI Investment Management Department .

The principal disclosure produced by the framework is the days-to-liquidate metric, computed on the basis that the AMC trades up to 25 per cent of each constituent stock’s 30-day average daily traded volume (ADTV) per day, with positions sorted by liquidity to determine the cumulative number of business days required to monetise 25 per cent and 50 per cent of the portfolio. The disclosure is required monthly, with publication on both the AMC’s own website and the AMFI website within 15 days of month-end. AMFI publishes a consolidated industry-wide table aggregating the disclosures across all reporting AMCs, enabling cross-AMC comparison.

The framework’s introduction in February 2024 was timed with the cumulative net inflows into small-cap and mid-cap schemes reaching approximately Rs 1 lakh crore over the prior 18 months. Small-cap funds had crossed Rs 2.5 lakh crore in aggregate AUM by early 2024, with the Nifty Smallcap 250 index having risen approximately 70 per cent in calendar year 2023. SEBI’s analytic concern was that a significant market reversal could trigger redemption pressure that the schemes’ liquidity profiles could not absorb without forced sales at distressed prices, replicating the Franklin Templeton 2020 dynamic in the equity-scheme context. The stress testing disclosure was intended to surface the liquidity-risk dimension that the existing riskometer framework (which captures price risk but does not fully capture liquidity risk) does not adequately reflect.

Background

The 2022 to 2023 small-cap inflow surge

From April 2022 to December 2023, Indian small-cap and mid-cap mutual fund schemes collectively received net inflows of approximately Rs 90,000 to Rs 1,00,000 crore. Several factors drove the surge:

• Strong retail SIP participation: Particularly in actively managed small-cap funds, which were marketed as long-horizon growth allocations.
• Superior recent performance: The Nifty Smallcap 250 rose approximately 70 per cent in calendar 2023 alone; the Nifty Midcap 100 rose approximately 47 per cent in the same period. Trailing-return-driven flows accelerated through the second half of 2023.
• Distribution incentives: Under the B30 incentive framework , AMCs and distributors had structural incentives to grow B30-sourced AUM, which was disproportionately retail-investor-driven and tilted toward growth-oriented schemes.
• Post-2020 retail participation: The broader retail participation surge in Indian equity markets post-COVID-19 produced sustained subscription pressure on equity schemes.

By early 2024, total AUM in SEBI Small Cap Fund category schemes exceeded Rs 2.5 lakh crore; Mid Cap Fund category AUM was approximately Rs 3.2 lakh crore. The combined Rs 5.7 lakh crore was a substantial share of the equity-MF universe.

Liquidity concerns

SEBI’s analytical concern was structural. Small-cap stocks (defined under the AMFI cap classification as stocks ranked 251 and beyond by market capitalisation) and mid-cap stocks (ranked 101 to 250) typically have substantially lower daily trading volumes than large-cap stocks. A significant market reversal could trigger rapid redemptions, forcing fund managers to sell small-cap stocks in a market where daily traded volumes are thin. The resulting sales pressure could amplify price declines (a “fire sale” dynamic), producing further losses to remaining unit-holders and potentially triggering further redemptions in a destabilising spiral.

The Franklin Templeton winding-up of 2020 had demonstrated the same dynamic in the debt-fund context, where credit-risk schemes faced an analogous liquidity-mismatch problem during the COVID-19 dislocation. The 2024 framework was SEBI’s pre-emptive equity-side analogue to the post-Franklin-Templeton debt-fund reforms.

Pre-2024 disclosure gaps

Before the February 2024 framework, the principal liquidity-risk disclosure for small-cap and mid-cap schemes operated through:

• The “Very High” riskometer label that small-cap funds typically carried, primarily reflecting price-volatility risk.
• The half-yearly portfolio disclosure showing constituent stocks.
• The Scheme Information Document risk-factor narrative.

None of these disclosures explicitly addressed the days-to-liquidate question that is central to the liquidity-risk dimension. The 2024 framework filled this gap.

SIP-cap voluntary actions

In late 2023 and early 2024, several large AMCs voluntarily imposed limits on fresh SIP registrations and lump-sum investments in their small-cap funds, citing the liquidity concerns. The voluntary actions were precursors to the SEBI framework, which formalised the underlying analytical basis (days-to-liquidate) into a standard disclosure rather than relying on each AMC’s discretionary self-imposition.

The February 2024 framework

Core obligations

SEBI Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14 imposes four principal obligations:

1. Monthly stress test: Every AMC managing a small-cap or mid-cap fund must conduct a stress test as of the last business day of each month, based on the end-of-month portfolio.

2. Standardised disclosure metrics: AMCs must compute and disclose:

   • Days to liquidate 25 per cent of the small-cap or mid-cap portfolio at the standardised assumption of trading up to 25 per cent of the 30-day average daily traded volume (ADTV) per stock per day.
   • Days to liquidate 50 per cent of the portfolio under the same assumption.

3. Publication timeline: Results must be published on the AMC’s website and the AMFI website within 15 days of the end of each month.

4. Conditional additional measures: SEBI reserved the right to prescribe additional measures (including mandatory SIP caps, subscription restrictions, mandatory portfolio rebalancing) if stress-test results indicate extreme illiquidity.

Scope

The framework applies to:

• Small Cap Fund category schemes (SEBI Small Cap Fund category, minimum 65 per cent in small-cap stocks).
• Mid Cap Fund category schemes (SEBI Mid Cap Fund category, minimum 65 per cent in mid-cap stocks).

The framework does not directly apply to large-cap funds (where underlying liquidity is generally not a concern), to multi-cap and flexi-cap funds (which have meaningful large-cap exposure providing inherent liquidity), or to debt schemes (which have a separate liquidity-risk framework under the swing-pricing rules).

Computation methodology

The days-to-liquidate calculation operates as follows:

Step 1: ADTV per stock

For each stock in the small-cap or mid-cap portfolio:

• The 30-day average daily traded volume on BSE and NSE combined is computed.
• The reference period is the prior 30 trading days as of the portfolio reference date.

Step 2: Per-day liquidation capacity per stock

SEBI prescribes the assumption that the AMC trades up to 25 per cent of the ADTV per day without materially moving the market. The per-day liquidation capacity per stock is:

Per-day capacity (shares) = 0.25 multiplied by ADTV (shares)

Step 3: Days to liquidate each position

For each stock:

Days to liquidate the position = (Position size in shares) divided by (Per-day capacity in shares)

A position of 10,000 shares in a stock with ADTV of 1,000 shares would require 10,000 / (0.25 multiplied by 1,000) = 40 days to fully exit.

Step 4: Aggregate portfolio metric

The positions are sorted by liquidity (most-liquid stocks sold first). The cumulative portfolio value that can be liquidated in each passing day is tracked, and the number of days to reach 25 per cent and 50 per cent of total portfolio value is determined.

Methodology caveats

The computation is a simplified liquidity-at-risk measure with several caveats:

• Single-scenario: The 25-per-cent-of-ADTV assumption is a single static scenario. Real-world liquidity in a market crisis typically falls substantially below 30-day ADTV, making the actual liquidation timeline materially longer.
• No market-impact modelling: The framework assumes no price impact from the AMC’s selling; in practice, sustained selling at 25 per cent of ADTV would produce price impact, particularly for smaller-cap stocks.
• Static portfolio: The framework uses the end-of-month portfolio snapshot; mid-month portfolio changes are not captured until the next month’s disclosure.
• No correlated-redemption modelling: The framework computes the time to liquidate from the AMC’s perspective; it does not model the systemic dynamic of multiple AMCs facing simultaneous redemption pressure across overlapping holdings, which would compress liquidity below the individual-AMC computation.

These caveats are widely acknowledged in industry commentary; the framework is positioned as a disclosure baseline rather than a comprehensive liquidity-at-risk measure.

AMC responses

Initial industry disclosures

The first stress-test disclosures published in March 2024 (for the February 2024 portfolio reference date) revealed significant variation across AMCs:

• Several AMCs with large small-cap fund AUMs disclosed liquidation windows of 20 to 30 business days for the 50 per cent threshold, with some larger schemes showing windows of 40 to 50 days.
• Mid-cap funds typically disclosed shorter windows (5 to 15 days for 50 per cent), reflecting the relatively higher underlying liquidity of mid-cap stocks compared to small-caps.
• The most-liquid 25 per cent of portfolios typically required 5 to 15 days across schemes; the longer tail of the 50 per cent threshold reflected the cumulative illiquidity of smaller positions.

Voluntary SIP caps

In the period immediately following the framework’s introduction:

• HDFC AMC: Imposed limits on fresh SIP registrations and lump-sum investments in HDFC Small Cap Fund.
• SBI Funds Management: Capped fresh SIP and lump-sum subscriptions in SBI Small Cap Fund.
• Nippon India AMC: Imposed similar caps on Nippon India Small Cap Fund.
• Tata Asset Management, DSP, and others: Various SIP-cap actions across the small-cap and mid-cap range.

The SIP caps were structured variously: some imposed absolute monthly caps (e.g., Rs 25,000 per month per investor); others closed fresh subscriptions while permitting continued SIPs in existing folios; others suspended SIP registrations entirely while permitting existing SIPs to continue.

AMFI consolidated publication

AMFI publishes an aggregated industry table of stress-test results on a monthly basis, enabling media, investor, and analyst comparisons. The publication has become a routine industry data point in monthly mutual-fund-industry commentary.

Relationship with riskometer

The stress-test framework is intended to complement, not replace, the riskometer framework. The two operate as parallel disclosures addressing different risk dimensions:

A small-cap fund will typically carry a “Very High” riskometer reflecting its price-volatility risk; the stress test adds the liquidity dimension showing the estimated days required to monetise the portfolio. SEBI’s stated intent is that investors in small-cap funds understand both dimensions:

• Price risk: Captured by the riskometer.
• Liquidity risk: Captured by the stress-test disclosure.

The combined two-dimensional risk disclosure is more informative than either alone.

Relationship with swing pricing

The 2024 stress-testing framework for equity schemes is structurally analogous to the 2021 swing pricing framework for debt schemes (introduced through SEBI Circular SEBI/HO/IMD/IMD-II DOF3/P/CIR/2021/576 dated 29 September 2021). The two frameworks operate as parallel liquidity-risk-management tools for their respective scheme universes:

• Debt schemes: Swing pricing adjusts the NAV under stressed conditions to allocate the cost of liquidity to transacting investors.
• Equity schemes (small and mid cap): Stress test discloses the days-to-liquidate metric.

The frameworks differ in their operating mechanism (price-adjustment versus disclosure) but share the underlying policy logic: surface the liquidity-risk dimension that conventional open-ended-scheme operation tends to obscure.

SEBI conditional powers

The framework reserves to SEBI the right to prescribe additional measures if stress-test results indicate extreme illiquidity. The implicit threshold is not specified in the circular but is widely understood to relate to days-to-liquidate metrics that would imply meaningful unit-holder harm under stressed conditions. Potential additional measures contemplated include:

• Mandatory SIP caps: Hard limits on monthly SIP inflows above a per-investor threshold.
• Subscription restrictions: Closure of fresh subscriptions while permitting existing SIPs to continue.
• Mandatory portfolio rebalancing: Direction to shift portfolio composition toward more-liquid holdings.
• Conversion to close-ended structure: In extreme cases, conversion of an open-ended scheme to a close-ended structure to eliminate the redemption-liquidity-mismatch.

To date, SEBI has not exercised these conditional powers; the voluntary AMC-level actions have served as the principal liquidity-management response, with the stress-test disclosure providing market discipline.

International comparison

The Indian 2024 stress-testing framework draws on similar regulatory developments in other markets:

• United States: The SEC’s 2016 Mutual Fund Liquidity Risk Management Rule (Rule 22e-4) requires open-end funds to maintain liquidity-risk-management programs including 7-day liquid-asset thresholds and bucket-based liquidity classification. The Indian framework is structurally similar but simpler.
• European Union: The European Securities and Markets Authority’s liquidity stress-testing guidelines for UCITS funds (effective September 2020) prescribe methodology and disclosure requirements.
• United Kingdom: The Financial Conduct Authority’s liquidity-management framework, particularly post-Woodford Equity Income Fund 2019 suspension, prescribes liquidity classification and management.

The Indian framework’s distinctive feature is the public monthly disclosure of the days-to-liquidate metric, which is a more transparent baseline than most peer-market frameworks.

Criticism and debates

Methodology simplicity

The single-scenario 25-per-cent-of-ADTV assumption has been widely criticised as too simplistic. Real-world liquidity in a market crisis (March 2020 COVID-19 dislocation, late-2018 IL&FS aftermath) typically saw liquidity fall to 10 to 20 per cent of normal ADTV across small-cap stocks. The framework’s stress-test estimates are therefore generally viewed as best-case estimates rather than realistic stress-scenario outputs.

Voluntary versus mandatory SIP caps

The framework’s reliance on voluntary AMC-level SIP caps has been argued to produce inconsistent application. Some large AMCs continued accepting unlimited SIP registrations through 2024 to 2025 despite the disclosed long liquidation windows. Industry commentary has periodically suggested mandatory SIP caps once specific stress-test thresholds are exceeded; SEBI has not adopted this approach.

Investor-engagement effectiveness

Monthly AMFI publications of stress-test data have generated limited retail-investor engagement. The technical nature of the disclosure (days-to-liquidate is not an intuitive risk measure for retail investors) limits its practical usefulness. Whether the disclosure substantively affects retail subscription decisions remains contested.

Cross-scheme correlation

The framework treats each scheme’s stress test independently, without modelling the systemic dynamic of multiple AMCs facing simultaneous redemption pressure across overlapping holdings. In a market stress where all small-cap fund AMCs simultaneously sought to liquidate, the assumed 25-per-cent-of-ADTV capacity would not be achievable in practice. The cross-scheme correlation issue is widely acknowledged but not addressed in the framework.

Coverage gaps

The framework covers small-cap and mid-cap Schemes per the SEBI categorisation. Multi-cap and flexi-cap schemes with substantial small-cap and mid-cap exposure (which are technically large-cap-plus schemes rather than small-cap or mid-cap schemes) are not directly covered, even though some of these schemes have meaningful liquidity-mismatch potential.

Recent developments

Monthly disclosure operationalisation

Through 2024 to 2026, the monthly stress-test disclosure has become a routine industry data point. AMFI’s consolidated table is published within the 15-day window each month. Media and analyst coverage of the disclosure has been sustained, particularly during periods of market stress.

Small-cap drawdown of early 2024

The post-framework period included a significant small-cap market drawdown in March and April 2024 (the Nifty Smallcap 250 fell approximately 12 per cent over six weeks). The drawdown produced moderate redemption pressure but no large-scale forced selling, with the stress-test disclosure framework receiving credit (in industry commentary) for the pre-emptive AMC-level SIP-cap actions that limited the build-up of further inflows during the late 2023 rally.

Extension to other categories

SEBI’s October 2024 consultation included a proposal to extend the stress-testing framework to other scheme categories, including the multi-cap and flexi-cap categories. The proposal is under industry deliberation; no firm extension has been notified.

Integration with the SEBI Investor Charter

The SEBI Investor Charter for Mutual Funds references the stress-test disclosure as part of the liquidity-risk awareness framework. Investors are expected to consider the stress-test metric alongside the riskometer when assessing small-cap and mid-cap scheme investments.

Real-time methodology consultation

Industry commentary in 2024 to 2025 has suggested moving from monthly to more-frequent (potentially weekly) stress-test disclosure, particularly during periods of market stress. SEBI has not adopted this enhancement; the operational complexity of more-frequent disclosure has been the principal counter-argument.

See also

• Mutual fund
• Mutual fund industry in India
• SEBI (Mutual Funds) Regulations, 1996
• SEBI Investment Management Department
• Mutual fund riskometer
• SEBI mutual-fund swing pricing
• SEBI scheme rationalisation circular 2017
• SEBI multi-cap reclassification 2020
• Franklin Templeton winding-up 2020
• Side-pocketing for debt mutual funds
• B30/T30 incentive framework
• SEBI Investor Charter for Mutual Funds
• Mid Cap mutual fund in India
• Large Cap mutual fund in India
• Flexi Cap mutual fund in India
• Multi-cap versus Flexi-cap
• Sectoral or Thematic mutual fund
• SIP in India
• SIP growth story in India
• Direct plan adoption in India
• Net Asset Value (NAV)
• NAV computation methodology
• AMFI
• SEBI mutual-fund compliance audit

References

1. SEBI Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14, 27 February 2024, Stress Testing for Small Cap and Mid Cap Schemes.
2. SEBI (Mutual Funds) Regulations, 1996, Seventh Schedule (investment restrictions), Second Schedule, as amended.
3. SEBI Master Circular on Mutual Funds, SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/137, 27 May 2024.
4. SEBI Circular SEBI/HO/IMD/IMD-II DOF3/P/CIR/2021/576, 29 September 2021, Swing Pricing Framework for Debt Mutual Funds.
5. AMFI Monthly Industry Stress Test Aggregation, Association of Mutual Funds in India.
6. AMFI Cap Classification Data (semi-annual), January and July editions.
7. SEC Rule 22e-4 (Liquidity Risk Management for Mutual Funds), United States Securities and Exchange Commission, 2016.
8. ESMA Guidelines on Liquidity Stress Testing in UCITS and AIFs, European Securities and Markets Authority, 2020.
9. FCA Liquidity Management for Investment Funds Framework, Financial Conduct Authority, United Kingdom.
10. AMFI Best Practice Guidelines on Liquidity Disclosure, Association of Mutual Funds in India.