Securities and Exchange Board of India (Sebi) has sent emails to certain asset management companies (AMCs) to confirm whether they are selling small-cap mutual fund schemes to senior citizens, according to media reports. Investment advisors usually recommend that senior citizens avoid investing in small-cap instruments, which are relatively riskier than other asset classes.

In one of the reports, Moneycontrol stated that Sebi has asked “at least one fund house” whether it has sold high-risk small-cap schemes to super senior citizens (those aged 80 and older).

Sebi’s emails have reportedly gone to several other fund houses. Small-cap mutual fund schemes invest in companies with less than Rs 5,000 crore market capitalisation. These funds are best suited for a long-term hold, typically seven years or more.

The revelation has created quite a stir and is hogging the media headlines. Moneycontrol reported that several AMCs are under Sebi’s scanner and has asked them to confirm from their investors whether they are aware of the high risks involved with such schemes. One of its sources at a fund house has reportedly told the outlet that industry-wide discussions are underway about creating a standard procedure to prevent such situations from arising again.

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Safety & Transparency

To boost transparency and safety in the stock market, Sebi had recently directed the Association of Mutual Funds in India (AMFI) to conduct stress tests on small and mid-cap funds on the 15th of each month starting March 15, 2024, following concerns that these funds may have been overvalued. The stress test primarily assesses the mutual funds’ claim of instant liquidity. It evaluates the portfolio’s liquidity positions by calculating the time required to sell 80 per cent of the most liquid assets, excluding the least liquid 20 per cent, to see how soon investors can get their money back if there is a rush to redeem when the equity markets collapse.

The results of the first round of the test in March, as per the report, show that it would take about six days and 14 days on average to liquidate 50 per cent of the mid-cap and small-cap mutual fund portfolios, respectively, if the markets collapse.

The AMFI market data for February released early this month showed that small-cap funds’ net inflow was Rs 2,922.4 crore, compared to mid-cap funds’ Rs 1,808.2 crore.

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Besides the stress test, AMFI has asked the AMCs to display critical metrics prominently on their websites in a simple language that investors can understand. These metrics include annualised standard deviation, which measures the standard deviation of the scheme portfolio and the benchmark index; portfolio beta, which measures the portfolio returns vis a vis the broader market movements; and portfolio trailing 12-month PE, which is calculated by dividing the current market price of the portfolio’s holdings by the trailing 12-month earnings per share (EPS). A higher PE ratio shows that portfolios are expensive compared to their earnings.