Speaking at a recent event, Gopalakrishnan emphasised the importance of proactively assessing the system’s capacity to withstand potential large-scale redemptions, particularly in the context of small- and mid-cap schemes.
Gopalakrishnan pointed out that while individual stress tests conducted by mutual funds have provided useful insights into idiosyncratic risks, they fall short of capturing broader, system-wide vulnerabilities.
“To fully understand the potential risks, it is crucial to model stress scenarios for the entire mutual fund ecosystem,” he stated.
This call for an industry-wide approach comes at a time when the holdings of mutual funds, domestic institutional investors, and individuals in mid-cap and small-cap stocks have risen significantly, accounting for 16.6% of the free float as of March 2024, up from 54.3% in March 2022.
The official from the Securities and Exchange Board of India (Sebi) highlighted the mismatch between the growing demand for securities and the market’s limited issuance of fresh paper.
In the fiscal year 2024 alone, the net demand for paper from mutual funds, domestic institutional investors, and foreign portfolio investors reached 3.6 lakh crores, while fresh issuances totalled less than two lakh crores.
According to Gopalakrishnan, this disparity could contribute to asset price inflation, particularly in the small and mid-cap segments.
Further compounding these concerns, Sebi has already taken steps to address potential risks in the small and mid-cap space.
Several large fund houses have voluntarily stopped lump-sum investments in small-cap schemes and capped the amount that can be invested via systematic investment plans (SIPs) in these schemes. These measures are aimed at preventing an overheating of the market, where a significant portion of capital is being concentrated in a limited number of stocks, potentially leading to inflated valuations.
Gopalakrishnan also referenced the stress testing conducted by mutual funds on individual schemes, which Sebi had mandated to be made public. The results, though encouraging, come with caveats that need to be considered.
He pointed out that while secondary market turnover and average daily delivery volumes have increased, which helps in managing redemptions, there remains a question of whether the market would be as receptive to large-scale sell-offs during times of stress as it is to the current demand.
In light of these challenges, Gopalakrishnan called on the industry to take the lead in conducting objective and credible stress tests that would help pre-empt any systemic risks.
He urged mutual fund managers and industry experts to engage in deliberate discussions on improving the clarity and communication of risks to investors, especially in the context of small and mid-cap investments.
“As fiduciary managers of people’s money, it is our responsibility to ensure that the investments held in trust are managed responsibly, with a clear understanding of the risks involved,” he emphasised.