SEBI Calls For Proactive Risk Assessments In Mutual Fund Industry; Here's What It Means

Speaking at a mutual fund event, Gopalakrishnan highlighted the importance of applying stress testing not only to individual schemes or fund houses but across the entire mutual fund ecosystem

Securities and Exchange Board of India’s (SEBI) whole-time member Ananth Narayan Gopalakrishnan said on Friday that the markets regulator has urged the mutual fund industry to conduct stress tests actively. These tests are crucial for reinforcing the industry’s resilience and are crucial for managing risk within the financial sector.

Gopalakrishnan stressed that SEBI’s focus on stress testing aims to better assess and manage liquidity risks, particularly in small and midcap equity schemes. Speaking at a mutual fund event, he highlighted the importance of applying stress testing not only to individual schemes or fund houses but across 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.

Different Levels Of Risk

He also highlighted the importance of improving the communication of risks associated with different mutual fund schemes. While the current risk measurement system is clear and has made a notable impact, it does not adequately distinguish between the varying risk levels of different investment schemes.

According to him, many schemes are broadly categorised as high-risk despite having distinct types of risks. The objective is to refine this system to reflect these differences while maintaining simplicity and clarity more accurately. One proposed approach is incorporating insights from stress tests, such as portfolio volatility and liquidity, to provide a more comprehensive risk assessment.

"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.

These comments coincide with a notable increase in mutual fund holdings by Domestic Institutional Investors (DIIs) and individual investors. As of March 2024, their holdings have risen to 60.6 per cent of the free float in all mid-cap and small-cap companies, up from approximately 54.3 per cent in March 2020.