SEBI stress testing framework for small/mid-cap mutual funds (2024)

The SEBI stress testing framework for small/mid-cap funds refers to the requirements introduced by SEBI circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14 dated 27 February 2024 that compel 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, respectively, under prevailing market conditions. The framework was SEBI’s response to sharp inflows into small-cap and mid-cap funds in 2022–2023 that created concerns about liquidity mismatch and the potential for a destabilising redemption rush if markets corrected sharply. It is grounded in the SEBI (Mutual Funds) Regulations, 1996 and administered by the SEBI Investment Management Department.

Background: the small/mid-cap inflow surge

From April 2022 to December 2023, Indian small-cap and mid-cap mutual fund schemes collectively received net inflows of approximately ₹90,000–1,00,000 crore, driven by:

• Strong retail SIP participation, particularly in actively managed small-cap funds.
• Superior recent performance of small-cap indices (Nifty Smallcap 250 rose over 70% in CY2023).
• Distribution incentives under the B30/T30 framework.

By early 2024, total AUM in small-cap funds exceeded ₹2.5 lakh crore. The concern was that 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, potentially amplifying price declines and creating further redemptions (a “fire sale” spiral).

SEBI also expressed concern about AMCs continuing to accept unlimited SIP registrations in small-cap funds even when portfolio liquidity ratios deteriorated.

The February 2024 circular

Core obligations

SEBI circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14 requires:

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

2. Disclosure metric: AMCs must compute and disclose:

   • The number of business days required to liquidate 25% of the small-cap and mid-cap portfolio (at average daily volumes over the past 30 trading days, assuming the AMC does not trade more than 25% of the average daily volume of any stock on any day).
   • The number of business days required to liquidate 50% of the portfolio on the same basis.

3. Publication timeline: The stress test results must be published on the AMC website and the AMFI website within 15 days of the end of each month.

4. Additional measures (if threshold exceeded): SEBI reserved the right to prescribe additional measures (including mandatory SIP caps, subscription restrictions, or mandatory portfolio rebalancing) if stress test results indicated extreme illiquidity.

Computation methodology

The liquidation timeline is calculated as follows:

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

• The 30-day average daily traded volume (ADTV) on BSE + NSE is computed.
• SEBI assumes the fund can trade up to 25% of the ADTV per day without materially moving the market.
• The number of days to fully exit each position = portfolio holding in shares / (0.25 × ADTV).
• The positions are sorted by liquidity (easiest to sell first).
• The cumulative value that can be sold in each passing day is tracked, and the number of days to reach 25% and 50% of total portfolio value is computed.

This is a simplified liquidity-at-risk measure, not a full-simulation stress test.

AMC responses and industry impact

Following the circular:

• Several AMCs with large small-cap fund AUMs disclosed liquidation windows of 20–30 business days for the 50% liquidation, prompting voluntary announcements of SIP caps.
• HDFC AMC, SBI Funds Management, and Nippon India AMC (among others) imposed limits on fresh SIP registrations and lump-sum investments in small-cap funds.
• AMFI published an aggregated industry table of stress test results monthly, enabling media and investor comparisons.

The riskometer link

Stress test disclosures are intended to complement the “Very High” riskometer label that small-cap and mid-cap funds carry. While the riskometer captures the volatility and credit risk profile, the stress test adds a liquidity dimension that the riskometer methodology does not fully capture. SEBI’s intent is that investors in small-cap funds understand:

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

Criticism and limitations

• Methodology simplicity: The 25% ADTV assumption is a single-scenario estimate; real-world liquidity in a market crisis typically falls far below ADTV, making the actual liquidation timeline much longer.
• Self-imposed SIP caps: Voluntary SIP caps by AMCs were not uniformly applied; some large AMCs continued accepting unlimited SIP registrations.
• Disclosure fatigue: Monthly AMFI publications of stress test data generated limited investor engagement; the technical nature of the disclosure limits its practical usefulness for retail investors.

See also

• Mutual fund
• SEBI (Mutual Funds) Regulations, 1996
• Riskometer framework (India)
• SEBI multi-cap reclassification 2020
• SEBI MF swing pricing
• SEBI Investment Management Department
• B30/T30 incentive framework
• Mutual fund industry in India
• SEBI scheme rationalisation circular 2017

References

1. SEBI Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/14, 27 February 2024, Stress testing for small/mid-cap funds.
2. SEBI (Mutual Funds) Regulations, 1996, Second Schedule.
3. AMFI, “Stress test results, monthly publication”, amfiindia.com.
4. SEBI Master Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/137, 27 May 2024.