Large exposure to mid and small- caps accelerated damages to fund portfolios in 2008 and pose significant risk now as a falling share market cripples trading volumes, making it tough for managers to exit holdings.
For 55 open-ended stock funds, managing more than 400 billion rupees or two-thirds of the assets of diversified equity funds, will take an average 10 days or more to liquidate their holdings of mid and small-cap shares, data from fund tracker ICRA shows.
It may get worse, analysts warn, as investors favour bigger firms considered relatively better placed to survive a downturn, making exits tougher for fund managers who have parked a third of their portfolios in mid and small-cap stocks since at least 2007.
While funds are not facing sharp redemptions yet, industry watchers say investors should be mindful of risks associated with mutual funds that invest mainly in shares of medium and small-sized firms in a slowing economy.
"Liquidity is a risk point that people should consider," said Krishnan Sitaraman, head of fund services at CRISIL. "This could be an issue when redemptions are large-scale."
Less than a fourth of India's open-end diversified stock funds can liquidate portfolios in a day as compared to nearly a third in same period last year, the data showed.
"Risk has gone up... stocks which were relatively liquid have become illiquid because of the volumes declining because of the drastic fall in the market," said Aditya Agarwal, managing director and head of India for fund research firm Morningstar.
Sameer Narayan, head of equity, Fortis Investment Management, said the daily market volume had crashed to almost a tenth to $2.5 billion in the last one year.
However, large cash holdings of the funds may help them meet redemptions in the near-term, all three said.
Equity funds have held an average 16 percent of their assets as cash at the end of January.
"We don't expect any significant crisis in days to come," Sitaraman said.
MID-CAP BETS
Indian funds have historically relied heavily on mid- and small-caps to produce outperformance.
The strategy paid rich dividends in five years ending 2007 when the BSE 500 index rose seven times, far higher than about sixfold gain in the benchmark index.
In 2008, as tide turned against stocks given large-scale sell-offs by foreign portfolio investors, the benchmark index dropped 52 percent, while the BSE 500 index fell 58 percent.
The mid-cap and small-cap indices plunged 67 percent and 72 percent respectively.
Asset values of stock funds fell an average 54.7 percent, losing the entire gain made in the previous two calendar years and recording their worst annual fall, data from global fund tracker Lipper showed.
Analysts say there could still be opportunities to pick multi-baggers among the battered small and mid-caps but as the economy slows further from an expected 7.1 percent growth in 2008/09, many smaller firms are likely to face pressure as debt levels rise and lenders shy away from funding them.
In a research note last week, CLSA said profits of small and mid-caps fell 83 percent in December quarter as compared to a modest 7 percent decline for bluechip firms part of the benchmark index and advised clients to avoid shares of smaller firms.
For 55 open-ended stock funds, managing more than 400 billion rupees or two-thirds of the assets of diversified equity funds, will take an average 10 days or more to liquidate their holdings of mid and small-cap shares, data from fund tracker ICRA shows.
It may get worse, analysts warn, as investors favour bigger firms considered relatively better placed to survive a downturn, making exits tougher for fund managers who have parked a third of their portfolios in mid and small-cap stocks since at least 2007.
While funds are not facing sharp redemptions yet, industry watchers say investors should be mindful of risks associated with mutual funds that invest mainly in shares of medium and small-sized firms in a slowing economy.
"Liquidity is a risk point that people should consider," said Krishnan Sitaraman, head of fund services at CRISIL. "This could be an issue when redemptions are large-scale."
Less than a fourth of India's open-end diversified stock funds can liquidate portfolios in a day as compared to nearly a third in same period last year, the data showed.
"Risk has gone up... stocks which were relatively liquid have become illiquid because of the volumes declining because of the drastic fall in the market," said Aditya Agarwal, managing director and head of India for fund research firm Morningstar.
Sameer Narayan, head of equity, Fortis Investment Management, said the daily market volume had crashed to almost a tenth to $2.5 billion in the last one year.
However, large cash holdings of the funds may help them meet redemptions in the near-term, all three said.
Equity funds have held an average 16 percent of their assets as cash at the end of January.
"We don't expect any significant crisis in days to come," Sitaraman said.
MID-CAP BETS
Indian funds have historically relied heavily on mid- and small-caps to produce outperformance.
The strategy paid rich dividends in five years ending 2007 when the BSE 500 index rose seven times, far higher than about sixfold gain in the benchmark index.
In 2008, as tide turned against stocks given large-scale sell-offs by foreign portfolio investors, the benchmark index dropped 52 percent, while the BSE 500 index fell 58 percent.
The mid-cap and small-cap indices plunged 67 percent and 72 percent respectively.
Asset values of stock funds fell an average 54.7 percent, losing the entire gain made in the previous two calendar years and recording their worst annual fall, data from global fund tracker Lipper showed.
Analysts say there could still be opportunities to pick multi-baggers among the battered small and mid-caps but as the economy slows further from an expected 7.1 percent growth in 2008/09, many smaller firms are likely to face pressure as debt levels rise and lenders shy away from funding them.
In a research note last week, CLSA said profits of small and mid-caps fell 83 percent in December quarter as compared to a modest 7 percent decline for bluechip firms part of the benchmark index and advised clients to avoid shares of smaller firms.
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