Stress Test Results Put Risk Of Investing In Narrow Themes In Better Perspective

India's market regulator, through its latest consultation paper, has called for disclosure of the results of stress tests for all schemes. The current mandate calls for the disclosure of stress test results of the small- and mid-cap schemes.

The paper calls for the results of all schemes to be made available for investors. A stress test essentially tests the liquidity of the portfolio. The time that a portfolio takes to liquidate will depend on the stocks and the market value of the same.

"Surge in redemptions during sharp downturns can put pressure on mutual funds, and to get an estimate on the robustness of the liquidity mechanism in such times, the concept of the stress test was introduced (initially) in the mid- and small-cap space," said Parbleen Bajpai, founder of FinFix.

With a proposal calling for more disclosure, the information can help the investors understand the risk and liquidity of the fund better.

"It's a good measure; it's one more additional data point. When they are disclosing data for small- and mid-cap schemes, they should do it for all schemes," said Mohit Gang, co-founder of Moneyfront.

Though this data being made available is a good move, the question of the usage of this information by investors remains.

"I'm not sure how many investors are looking at this. Had that been the case, then the mid- and small-cap inflows would have reduced a little. That has not been the case in the last one year, as flows have only been increasing even after these results are disclosed," said Gang.

It's a good measure for advisors and the distributor community to have a look and recommend accordingly, said Gang. Understanding risk and liquidity tends to be overshadowed by the dazzle of recent performance. Essentially, the portfolio of thematic and sectoral funds that have managed to return up to 40% in the past has narrow themes and concentrated stocks.

The category is the largest among actively managed equity funds, with Rs 4.55 lakh crore of assets under management. The inflows into the category during September have been recorded at Rs 13,254 crore.

The level of inflows into the thematic and sectoral space has been a cause of concern as many investors tend to invest chasing past returns. The risk factor is higher in very concentrated and small themes, said Bajpai.

"Huge inflows from investors tend to inflate the price of stocks. Thus, extending the stress test process to other categories, especially thematic and sectoral funds, is a step in the right direction," she said.

Disclosure of stress test results of schemes under the sectoral and thematic may bring into perspective the risk and liquidity of these funds.