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We continue to believe the first signs of US markets topping out will be when clear signs of rates cutting are visible

• We had mentioned in last week’s newsletter that the week was crucial for higher movement, unfortunately these actions led to a severe correction in some pockets (though don’t make the mistake yet of calling this a big correction, with the kind of upside we have seen, this is just a minor blip 😊 as we see it)
  

• With SEBI trying all measures to curb speculative activity in small and mid caps, the impact was seen in these indices with both down around 5%
  

• SEBI’s stress test results were out for small and mid cap funds – Read Question of the Week section below to see how to interpret the results
  

• US markets continue to be fairly strong
  

• Precious metals continue to do well

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What do I infer from the stress test results of mid and small cap funds released by AMFI?

Dear User,


Stress test results of mid and small cap funds as demanded by SEBI have been published and though it is indeed a great document for analysis and super helpful in selection which fund is appropriate for investors, some aspects need to be seen in a nuanced manner.

Let’s go to the most important aspect of this report which is unique - I.e the no of days taken for liquidation of the portfolio - this essentially means if the fund faces redemption and has to liquidate the holdings to repay all the investors how long would it take to do the same. The report mentions some funds that are liquidable quite quick in a few days there are some where it could take a few weeks.

Let’s talk about when this aspect comes into practical effect - I.e Massive panic in the markets where there are a large number of redemption requests within a day or a few days (possibly more than 25%)

In such a case the fund has to sell its holdings to meet the demand and we have seen sometimes in the past (especially in 2008) where some funds have sold shares at distress levels to meet this redemption pressure.

The liquidity days mentioned here will only be worse as these numbers are in current times when markets are buoyant and high liquidity - these numbers can easily get much much worse in bad markets where liquidity can drop massively (greater than 50% or even more in very small cap stocks)

Who should worry -

a) If you have more than 10% of your entire investments in a single small or mid cap fund

b) If you are prone to panic selling (here rather than fall prey to questionnaires we suggest that anyone who hasn’t seen the 2008 crash is susceptible to this panic bias)

In case if either of these isn’t true then in our mind one shouldn’t worry much about this, having said this even if one themselves don’t panic there is a possibility of them being impacted due to the panic of others hence

To summarise

A) Do not invest more than 5% in any single small or mid cal fund of your equity exposure

B) Certain funds that are low in these parameters viz. a combined measure of high liquidation days and high volatility should be avoided or have a small exposure (less than 2.5%)

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