Mutual Fund industry asked to conduct stress tests

Delhi Delhi: Market regulator Sebi has asked the mutual fund industry to actively undertake stress testing, a key component of risk management for the financial sector, which will help strengthen the ecosystem, its whole-time member Anantha Narayan Gopalakrishnan said on Friday. The regulator’s stress test emphasises the need to assess and manage liquidity risks, particularly in small and medium equity schemes. Speaking at a mutual fund event, Gopalakrishnan highlighted the importance of modelling stress scenarios not just for individual schemes or fund houses but for the entire mutual fund ecosystem. “It is also important to model stress scenarios for the entire overall mutual fund ecosystem. I would strongly encourage the industry and AMFI to come forward and actively conduct objective and credible industry-wide stress tests,” Gopalakrishnan said. He also emphasised the need to find better ways to communicate the risks associated with various mutual fund schemes. The Sebi official noted that while the current risk measurement system is straightforward and has had a significant impact, it does not fully capture the differences in risks between different investment schemes. According to him, many schemes are simply labelled as high risk, even though they have different types of risks. The goal is to improve this system to better reflect those differences while also keeping it simple and easy to understand. One possible approach is to consider portfolio volatility and liquidity from stress tests to give a clearer picture. He said, “While ensuring simplicity and ease of understanding remains a key objective, perhaps the underlying volatility of the portfolio and liquidity of the portfolio from stress tests can be used to provide better information for all.

” This comes at a time when mutual fund holdings by domestic institutional investors (DIIs) and individuals have grown from about 54.3 per cent of the free float of all mid-cap and small-cap companies as of March 2020 to 60.6 per cent by March 2024. Many fund houses have actively stopped lump sum investments in certain small-cap schemes and have also restricted the amount that can be invested in small-cap schemes through systematic investment plans (SIPs). He also highlighted the potential mismatch between the demand for paper and the supply of new paper coming into the ecosystem. Gopalakrishnan said the industry could make further progress in streamlining operations and improving efficiency for investors. “At a time when instant fund transfers have become ubiquitous in our country, perhaps we should focus on improving our internal processes and security settlement ecosystem to ensure that investors get funds on the day of settlement itself and not a day or two later,” he said. Over the past few years, the mutual fund industry has made impressive progress and is now playing a key role in channelling financial savings towards risk capital formation. This was driven by stable macros, increased formalisation, strong corporate earnings, digitisation and user-friendly access. Further, the number of mutual fund investors is projected to grow from around 2 crores as of March 2019 to around 4.7 crores by June 2024, an impressive compound annual growth rate of 18 per cent during that period. Gopalakrishnan informed that several exciting initiatives are underway with inputs from all stakeholders. These include proposed low-ticket SIPs, splitting regular SIPs into smaller, more accessible units (sachetisation and tokenisation), and the introduction of “mutual fund lite” regulations. These new regulations will simplify rules for passively managed funds, reduce compliance burden and encourage competition and innovation. Additionally, a new category of high-risk schemes has been proposed for investors with a higher tolerance for risk.