Sebi Asks Mutual Fund Industry To Proactively Conduct Stress Test

Markets regulator Sebi has asked the mutual fund industry to proactively conduct stress tests, a key component of risk management for the financial sector, which will help strengthen the ecosystem, its whole-time member Ananth Narayan Gopalakrishnan said on Friday.

The regulator’s stress testing emphasizes the need to assess and manage liquidity risks, especially in small and midcap 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 composite mutual fund ecosystem. I would strongly encourage the industry and AMFI to take the lead and proactively conduct objective and credible industry wide stress tests. themselves,” Gopalakrishnan said.

He also emphasized the need to find better ways to communicate the risks associated with different mutual fund schemes.

According to him, many schemes are just labelled as high risk, even though they have different kinds of risks. The goal is to improve this system to better reflect those differences while keeping it simple and easy to understand. One possible approach is to consider the portfolio’s volatility and liquidity from stress tests to give a clearer picture.

“While ensuring simplicity and ease of understanding remains a key objective, perhaps the underlying volatility of the portfolio along with the liquidity of the portfolio from stress tests could be used to provide better colour all around,” he added.

This comes at a time when the holdings of mutual funds by Domestic Institutional Investors (DIIs) and individuals have risen from about 54.3 per cent of free float of all mid cap and small cap companies as of March 2020 to 60.6 per cent as of March 2024.