Mid- and small-caps continue to bleed amid release of stress test results; what should one do?

Mid- and small-cap indices slipped over 1 per cent on Friday, March 15, after several fund houses that invest in small and midcap stocks, on the instructions of the mutual fund regulatory body, the Association of Mutual Funds in India, released stress tests of their schemes.

As of 11:13 a.m., the Nifty Mid Cap 100 traded 1.41 per cent while the Nifty Small Cap 100 was down 1.17 per cent. Meanwhile, S&P BSE MidCap was down over 1.6 per cent and S&P BSE SmallCap traded 1.19 per cent lower.

Last month, Sebi asked AMFI to ask fund managers to moderate flows into mid- and small-cap schemes, citing a "bubble" in the broader market.

What should investors do? 

Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, believes that even without stress tests, one thing is clear: the broader market valuations are expensive, and in some pockets, valuations are frothy. This is unsustainable.

"Even when prospects for certain sectors are good, valuations have run ahead of fundamentals. Low floating stock in many segments has resulted in prices shooting up," said Dr. Vijayakumar. The expert added that focusing on large-cap stocks would be safer than chasing small-caps with stretched valuations.

Independent market expert Ambareesh Baliga suggests reducing the weightage of those funds that are stretched or borderline cases.

How is stress test affecting the mid-and small-cap indices?

As per Atul Parakh, CEO of Bigul, the release of stress test results may cause initial dips in mid- and small-cap indices, and liquidation time, if extended, could trigger selling as investors fearing difficulties in retrieving their money would accelerate dumping shares and book profit. 

Baliga sees stress tests as a dangling sword and says that some of the funds on the liquidation days are a bit stretched. Further, the expert said that analysts are waiting for directives from Sebi or AMFI, as corrective action needs to be taken by those that are on the borderline or stretched.

"Although nobody expects such stress to come where all the funds become sellers the same day, in such an eventuality even those with the best stress test case could become casualties. However, it weighs on the sentiment, and due to this fresh buying in micro and small caps, it may be held back, resulting in a further correction in this space," said Baliga.

What does the stress test mean for AMCs?

The long-term effect depends on the overall results. The tests help AMCs evaluate their portfolio's vulnerability to large-scale redemptions and identify areas for improvement. Positive stress test results demonstrate adherence to Sebi regulations regarding liquidity management.

As per Baliga, these stress tests bring to the fore the risks of investment, which hitherto most retail investors would have been ignoring. It’s a reminder to investors not to put all the eggs in the same basket.

Also Read | MFs' stress tests: Here is everything you need to know

Time taken to liquidate by various fund houses 

Catch the latest stock market updates here. For all other news related to business, politics, tech and auto, visit Zeebiz.com.

DISCLAIMER: The views and investment tips expressed by investment experts on zeebiz.com are their own and not those of the website or its management. zeebiz.com advises users to check with certified experts before making any investment decisions.