Small cap funds are still the top choice for investors seeking high-risk investments for their potential for significant returns. Despite fluctuations in the market, these funds saw a net inflow of Rs 4,092 crore in March 2025, bringing the total inflow for the fiscal year to Rs 41,673 crore, as per data released monthly by the Association of Mutual Funds in India (AMFI). Smallcap schemes have experienced a 15.7% decline over the past six months, the largest drop among diversified equity categories.
The latest stress test results for March 2025, conducted on small cap mutual funds, have highlighted potential liquidity challenges within the sector. The findings reveal that liquidating 50% of high-risk small cap mutual fund portfolios could take between 25 and 57 days. These funds are mandated to invest at least 65% of their assets in small cap stocks, but many, including the DSP Small Cap Fund, have invested as much as 89% in these stocks. This heightened concentration in small caps could amplify liquidity risks under stress conditions. The Securities and Exchange Board of India (Sebi) requires these stress tests to be disclosed monthly, with the results available on the Association of Mutual Funds in India (AMFI) website by the 15th of each month, based on the previous month’s data.
Notably, the Axis Small Cap Fund would require 25 days to liquidate half of its portfolio, whereas it takes 13 days for 25%. The HDFC Small Cap Fund faces a more challenging scenario, needing 57 days to liquidate 50% and 28 days for 25%. Meanwhile, the Quant Small Cap Fund is projected to need an extended 73 days to achieve a 50% liquidation in stressful market conditions. These results underscore the varying levels of liquidity risk associated with different funds in the small cap segment, potentially influencing investor confidence and decision-making in the mutual fund market.
Compared to the stress test results from February, which indicated a maximum of 36 days to liquidate 25% of portfolios, the March data marks a significant increase in liquidation periods under stress. For example, while the Axis Small Cap Fund took 12 days in February for a 25% portfolio liquidation, the timeline has now extended. A similar trend is seen in the DSP Small Cap Fund and HDFC Small Cap Fund, highlighting a potential trend of increasing liquidity risks as market conditions fluctuate. This shift could prompt fund managers to reassess their asset allocations and liquidity management strategies to mitigate risks.
These stress tests—mandated by SEBI from March 2024 onward—require mutual fund houses to disclose how many days it would take to liquidate 25% and 50% of their small and mid-cap portfolios under pro-rata stress scenarios. The reports are updated monthly and exclude the bottom 20% most illiquid assets from the calculation.
The regulatory oversight by Sebi ensures transparency in the mutual fund sector, prompting fund houses to publish monthly stress test results underpinned by the exclusion of the 20% least liquid securities from portfolio calculations. This regulatory requirement aims to provide a realistic view of the potential liquidity scenarios that funds might face. Given the current stress test data, it is crucial for investors to remain informed about the liquidity conditions of their investments, especially in high-risk categories such as small cap funds, which tend to be more volatile.
In the broader context, these stress tests indicate the need for strategic positioning by mutual funds to manage liquidity effectively. As the market conditions continue to evolve, fund managers are likely to face increased pressure to balance returns with liquidity risks. Comparatively, other funds like the DSP Small Cap Fund, which has allocated a significant portion of its assets to small cap stocks, will need to navigate these challenges carefully. Overall, these findings serve as a critical reminder of the importance of robust liquidity management and strategic asset allocation in the mutual fund industry.