According to the SEC, this key metric for stress tests shows that even if investors flock to these stocks, the small-cap market has a higher liquidity risk due to their high return commitments. According to some experts, high liquidity risks may also indicate a lower quality of fund investment.
On average, between the first such stress test conducted in February 2024 and the latest in January, the time required to liquidate 50% of the small fund portfolio increased by 39.4 days. The time required to liquidate 25% of the portfolio has increased by 19.8 days.
Funds need to be able to liquidate the portfolio to meet redemption, rebalancing or managing risks. Longer liquidation times may delay investors’ exits, resulting in lower-priced, deadly sales, affecting the net asset value of their holdings.
“If the fund grows significantly, or if it acquires a large proportion of assets in a short period of time, it can become very challenging for the manager to run the fund in the same way as before,” said Director Kaustubh Belapurkar. Research firm funding research.
“They may need to dilute the task by buying more stocks or starting to improve the market cap curve and buying large names to manage liquidity. This is not ideal because it is not the reason why investors give them money in the first place.”
To address this potential risk, many small funds have adopted a “soft shutdown” strategy that limits new inflows to existing investors or system investment plans (SIPS). This approach helps control inflow rates and better manage liquidity issues.
Belapurkar added that while retail investors in India are spread across many small investments, which helps reduce liquidity risks, recent market corrections may stabilize small investments as investors begin to look for other opportunities.
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Part of a small investment in liquidity risk
Dhirendra Kumar, founder and CEO of Value Research, advises investors not to consider liquidity risk indicators as face value.
“This liquidity metric is used to measure the liquidity of a smaller mutual fund portfolio…it shouldn’t actually be considered a scientific document. It’s a very mechanical calculation. It just tells you if the fund is tomorrow To do this, it will take how many days to sell the entire portfolio,” he said.
Liquidity risk is an inherent part of investing in small capital, he said, adding that small cap funds provide professional oversight, better diversification and liquidity management than individual investors who buy small caps directly.
“In my opinion, with higher returns, you can get compromised compensation through higher returns,” Kumar said, elaborating on the importance of selectivity in small cap mutual funds. There are about 4,600 small-sized ones – CAP has invested only about 680 there, and the rest is totally junk, or total fraud.
Kumar also noted that small cap funds “allow up to 40% of their portfolios to increase overall liquidity”.
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A red flag
However, Kumar acknowledged that high liquidity risk indicators may indicate that the fund has invested in low-quality stocks.
“The fund’s high liquidity metrics may actually indicate that they have invested in too many bad companies. So I see it as a relative code, not an absolute measure,” he said.
Vinit Sambre, head of stock at DSP mutual fund, also increased within the days when the potential liquidation of the portfolio may require liquidation, but assured investors that this is a dynamic measure affected by the market cycle.
“We don’t see a lot of liquidity risks compared to the most challenging redemption periods we have in the past,” he said.
Avoid overexposed and diversified
Experts say retail investors paying attention to rising liquidity risks should focus on disciplined investments and appropriate diversification.
“Small Cap funds always bring higher risks, which is a known fact. Allocation to 10-20% of their overall portfolio, don’t worry about the current versus the small hat,” said Harshad Chetanwala, co-founder of MyWealthGrowth.com. Related market conditions.”
However, he warned that investors who are overly exposed to small hats may be more susceptible to market volatility.
“The key is to stick to diversity and not wear small hats or even mid-covers. “There are a lot of investors who have been disciplined and even today’s overall portfolio will not be affected much.” ”
Little hat bait
Abhishek Kumar, SEBI registered investment advisor and founder of Sahajmoney, pointed to other shocking trends that have emerged in SEBI stress test data.
“Stress tests reveal a serious liquidity crisis for India’s booming small-cap mutual funds, and the highest funds now take more than 50-60 days to liquidate half of their portfolio, an increase of 9.4 days from 2024 in 2024. .”
Abhishek Kumar added that despite the significant increase in liquidity efficiency of mid-cap funds, investor inflows continue to target small hats.
“The Chinese stock alternative shows a 58% increase in liquidity efficiency, but investors continue to be flooded,” he said. ₹2.5 billion (trillion), regulators are facing growing pressure to address the dangerous mismatch between rapid growth and a decline in export liquidity. ”
