Corporate level structural intervention by way of training and enhancing governance practices, regular audits and inspections by the regulatory authorities coupled by the creation of databases for strengthened financial disclosures could go a long way in mitigating any kind of possible liquidity risks associated with small and mid-cap funds, said a report by ICRA Analytics.
SEBI had recently mandated routine stress tests to be conducted on small and mid-cap funds to highlight the potential liquidity risk associated with these funds when the markets come under pressure. Further, the report stated that while stress testing is a good approach to contain risks, few interventions at the structural level could help prevent a situation of excessive valuation.
Availability of a disclosure platform to capture near real time key data from companies would also help enable better monitoring through capturing of Early Warning Signals (EWS), said Ashwini Kumar, Senior Vice President and Head Market Data, ICRA Analytics.
The mutual fund industry has witnessed increased investments in small and mid-cap funds particularly from retail investors over the last few months with the stock markets touching new highs. The small cap funds which invest in companies with market cap up to Rs 5000 crore and mid-cap funds which invest in companies with market cap between Rs 5000 to Rs 20000 crore, have been the largest recipients of funds flowing to the markets, ICRA maintained.
The net AUM of open-ended small cap schemes grew by 89 per cent at Rs 2.49 lakh crore as on February 29, 2024, up from Rs 1.32 lakh crore in February 2023. Net inflows into small-cap funds increased by 30 per cent at Rs 2922 crore in February 2024, as against Rs 2246 crore last year. The open-ended mid-cap schemes witnessed 61 per cent growth in net AUM as on February 29, 2024 at Rs 2.96 lakh crore, up from Rs 1.83 lakh crore last year while net inflows remained almost flat at Rs 1808 crore in February 2024 (Rs 1817 crore in Feb 2023)
“Till recent times, investors would aggressively chase large cap, but the recent initiatives undertaken by the government to strengthen small and medium businesses by supporting them with necessary policy support and programmes is boosting intrinsic growth in such companies leading to better employment generation and bringing about a balanced growth across remote corners of the country. All these are providing a strong pull-factor for investors to include these categories of equities for value investing. However, given the steep surge in these indexes, it is imperative to check if the intrinsic value or future value is in line with the steep valuation particularly from the risk management perspective. Disclosure of risk-parameters and development of adequate stress tests is the need of the hour, educating investors about nuances of investments in schemes. This can be done by democratising information and undertaking routine training to help investors understand and assess risks better before investing,” Ashwini Kumar said.
Per ICRA, there is also a need to have investor-management discussion with greater frequency and shift to research-based investment from the growing trend of algo based investment/trading.
The small and mid-cap funds have been able to stir huge market interest on the back of generating exceptionally high returns. High valuation without corresponding intrinsic and future value can result in a build-up of risk. Thus, realistic valuation is the key for optimum resource allocation and for macro stability.
“If India has to grow evenly, mid cap and small cap adds flavors and diversity and also underlines the story of aspiring India. Identification and Prevention of risk from irrational exuberance shall be the target of all probable measures which in turn helps boost confidence in these sectors and to impart stability to the market. Hence necessary steps have to be initiated to intervene at the right point to gauge rationality which in turn protects the interests of the investors,” Ashwini Kumar pointed out.