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Taking corrective action after a stock market crash is like putting on sunscreen after getting sunburned.
Now think about this
You invested in a smallcap mutual fund. It was performing well, returns were good and everything looked good. But then, market corrected, suddenly panic started and investors started submitting massive redemption requests.
In this situation, a few questions arise
- Can your small cap mutual fund handle that huge redemptions?
- Or will your investment get stuck, temporarily inaccessible, right when you need it most?
In this blog, I will walk you through a concept that directly impacts the safety of your investments in mid cap and small cap mutual funds, SEBI’s mandated Stress Test. Now you must be wondering what is mutual fund stress test and is my mid cap and small cap funds safe?
Let’s find out!
What is Mutual Fund Stress Test for Mid cap and Small cap Funds?
Before we jump to the what is mutual fund stress test, you need to understand this first.
SEBI mandated the mutual fund stress test because mid cap and small cap mutual funds witnessed record breaking inflows between the end of 2023 and the beginning of 2024.
To give you an idea in 2023 alone, small cap mutual funds saw net inflows of ₹41,035 crore, the highest among all equity fund categories.
Between 2023 and February 2024, small cap mutual funds saw a net inflow of ₹42,037 crore. Mid cap funds also gained strong investor interest, with net inflows of ₹23,346 crore during the same period.
And
Between 2023 and 2024, BSE MidCap Index surged by nearly 62% and BSE SmallCap Index rose around 57%, while benchmark Sensex climbed just 24% during the same period.
After the rapid rise in popularity of small and mid cap funds, SEBI raised a key concern: are retail investors aware of the risks involved in these investments? Many are jumping in based solely on recent performance, without understanding that the valuations of these funds have already become quite stretched.
SEBI Chairperson Madhabi Puri Buch even described this situation as one of “irrational exuberance” and warned that it could lead to a potential bubble.
To tackle this, SEBI issued a mandate in March 2024 through AMFI, asking mutual fund houses to conduct a stress test, specifically for mid cap and small cap mutual funds. The goal was to assess how quickly these funds could liquidate their portfolios in a stock market crash or during extreme redemption pressure. SEBI had even described the situation in these segments as resembling a “bubble.”
In 2025, we all saw how badly the small cap and mid cap indices were hit. Even fundamentally strong stocks in these segments lost almost 50% of their value.
The purpose of a stress test is simple: it helps investors understand how your mid and small cap mutual funds might perform during tough market conditions. It gives a clearer picture of the fund’s risks and weak points, allowing you to make better investment decisions and manage your expectations during market downturns.
SEBI introduced this as a preventive measure, you can think of it as a “health check up” for small and mid cap mutual fund portfolios.
Why is the Stress Test Only for Mid & Small Cap Funds?
Large cap stocks like Reliance Industries, Infosys and HDFC Bank tend to be highly liquid. They have high daily trading volumes and there are always buyers and sellers available in the market.
Some mid cap and small cap stocks have lower liquidity. This means finding large buyers or sellers quickly can be difficult. When many investors try to redeem their units at the same time, it can lead to delays in the redemption process.
To measure and manage this liquidity risk, SEBI introduced the stress test specifically for mid and small cap funds.
Why Stress Test Matters in Mid and Small Cap Funds?
When the market faces a real crisis or panic, we start noticing things we usually ignore, like a sudden lack of buyers or people rushing to sell. Mutual fund stress tests are designed to prepare for such events. They use past examples like the 2008 financial crisis or 2020 COVID 19 crash to see how funds might perform during extreme conditions.
But during a real crisis, things don’t go as planned. There are many bigger issues that can affect how redemptions are managed. For example:
- Market wide liquidity freeze: When buyers disappear across the market, fund managers struggle to sell assets, even at discounted rates.
- Broker dealer failures: When intermediaries responsible for settling trades default or pause operations, causing transaction delays.
- Circuit breakers: When stock exchanges halt trading after major drops, limiting fund managers’ ability to respond quickly.
These situations can disrupt or delay redemption timelines.
That’s when investors realize how critical liquidity and stability are in mid and smallcap funds.
This is where the mutual fund stress test plays an important role. It doesn’t predict whether your investments are safe or not. Instead, it assesses how quickly and efficiently a fund can sell its holdings to meet mass redemptions during a market crash or panic. This is important for mid and small cap funds, which often hold stocks that aren’t very liquid.
For instance, if you’ve parked your emergency funds in a mid or small cap mutual fund that takes 50+ days to liquidate, you could be stuck during a crisis, unable to access your own money when you need it the most.
That’s why SEBI has mandated Asset Management Companies (AMCs) must conduct a stress test on their mid and small cap mutual fund schemes every 15 days.
In this test, they calculate how quickly the fund can complete redemption if 25% or 50% of the portfolio units are redeemed by investors. Specifically, they assess how many market days it would take for the fund to liquidate assets and pay back investors under such pressure.
This test is conducted based on some important assumptions:
- SEBI Excludes the Bottom 20% in Stress Tests
When SEBI runs stress tests on mutual funds, it doesn’t include the entire portfolio. In fact, only top 80% of the portfolio (by weight) is considered. Bottom 20% of holdings are excluded. Why?
Because bottom 20% consists of illiquid and micro cap stocks, the kind that hardly trade in the market. In a crisis situation, selling these stocks becomes extremely difficult. That’s why they are excluded during the stress test, to get a more realistic estimate of how quickly a fund could be liquidated under pressure.
But here’s the truth:
If a market crisis hits, fund managers can’t ignore that bottom 20%. They may have to sell those illiquid stocks as well, which is even more difficult and time consuming. This could delay the redemption process further than what the stress test suggests.
- Pro Rata Liquidation vs. Reality
Stress tests assume on a pro rata liquidation model, meaning all securities in a fund’s portfolio are sold in proportion to their weight.
For example, if:
Stock A has a 5% weight in the portfolio
Stock B has 3%
Then, to liquidate 50% of the portfolio, the fund would theoretically sell 2.5% of Stock A and 1.5% of Stock B.
But in the real world, that’s not how it happens.
Fund managers usually sell the most liquid stocks first, the ones that can be sold quickly and easily. The illiquid ones are left for later. So the actual liquidation doesn’t follow the neat pro rata model. It’s more tactical and based on what can realistically be sold in the market.
- 10% Daily Volume Rule and Why It’s Not the Whole Story
Under normal market conditions, a mutual fund can sell up to 10% of a stock’s daily trading volume without disturbing the market too much.
But in a stress scenario, like a market crash, SEBI’s framework assumes that trading volumes could triple. So if a stock normally sees 1 lakh shares traded daily, the stress test assumes that during a panic, volume could go up to 3 lakhs.
Still, funds can only use 10% of that volume – i.e., 30,000 shares per day in this example. So based on that, the stress test calculates how many days it would take to sell the fund’s holdings.
- Too many people are trying to sell
- Not enough buyers are available
- Bid prices fall
- Stock prices drop quickly
This phenomenon is called market slippage and it has a direct impact on Net Asset Value (NAV) of the fund, ultimately affecting your returns.
So while stress tests are helpful, It don’t capture the full picture. Just looking at volume isn’t enough to understand liquidity. You also need to consider:
- Bid ask spread
- Market depth
- Buyer availability
In short, stress test might tell you how many days it will take to sell but it doesn’t tell you at what price.
How Does Stress Test Impact Different Categories of Mutual Funds?
To understand the need for SEBI’s stress test, it’s important to look at how different mutual fund categories handle liquidity. Each category has a unique liquidity profile, which directly affects how quickly fund managers can sell the portfolio during market stress.
- Small Cap Funds
Small cap funds are the most at risk when the market goes down. That’s because many small cap stocks in mutual fund portfolios don’t get traded often , there aren’t always enough buyers or sellers. As per available data, it can take anywhere between 30 to 60 days just to liquidate 50% of their holdings.
- Mid Cap Funds
Mid cap funds are slightly better positioned than small caps but still face challenges. On average, it may take around 15 to 30 days to liquidate 50% of their holdings. The liquidity is better but not as strong as large caps.
- Large Cap Funds
These funds are considered the most liquid among the three. Since large cap funds mostly invest in blue chip companies, which are actively traded, buying and selling happen relatively easily. As a result, most large cap funds can liquidate 50% of their portfolio within 5 to 10 days.
That’s why SEBI has decided to focus its stress tests on small and mid cap funds, because these funds carry higher liquidity risks than large cap ones.
March 2024 vs. March 2025: Is Your Small Cap Fund Getting Stronger or Weaker?
When SEBI released the first round of mutual fund stress test results in March 2024, fund houses had assured investors that they would work on improving liquidity. But now the big question is, what does the ground reality look like?
To find out, we’re going to compare the March 2024 stress test results with the latest data from March 2025. We’ll focus specifically on small cap funds, so we can understand:
- Has there been any real improvement in liquidity?
- Or has the situation worsened over the past year?
Let’s dive into the actual numbers and see how resilient small cap funds really are today.
For this comparison, we’ll look at three popular small cap funds:
| Fund Name | 25% Liquidation (2024 → 2025) | 50% Liquidation (2024 → 2025) |
|---|---|---|
|
Nippon India Small Cap |
15 → 18 days |
29 → 36 days |
|
DSP Small Cap |
16 → 24 days |
32 → 47 days |
|
HDFC Small Cap |
22 → 28 days |
44 → 57 days |
- Let’s start with Nippon India Small Cap Fund
In 2024, if the fund had to liquidate 50% of its portfolio, it would have taken around 29 days. But in 2025, that number increased to 36 days. Similarly, liquidating 25% of the portfolio took 15 days earlier but now it takes around 18 days.
What does this mean?
If the fund needs to quickly sell its holdings, it will now take more time than before. In short, the liquidity risk has gone up.
- Let’s take a look at the stress test results of DSP Small Cap Fund
When it comes to liquidity, there’s some visible pressure. In 2024, if the fund had to liquidate 50% of its portfolio, it would have taken around 32 days. In 2025, the timeline has increased to 47 days.
Similarly, liquidating 25% of the portfolio took 16 days in 2024, but in 2025, it now takes 24 days.
What does this mean?
This indicates that if DSP Small Cap Fund needs to exit its holdings quickly, it would now take more time than it did a year ago.
- Let’s now talk about the stress test results of HDFC Small Cap Fund
When it comes to liquidity, the stress has increased this year. In fact, in 2025, the time required to liquidate the fund’s portfolio has gone up compared to 2024.
In 2024, if the HDFC Small Cap Fund had to liquidate 50% of its portfolio, it would have taken about 44 days. In 2025, that number has increased to 57 days.
Similarly, selling 25% of the portfolio took 22 days last year. This year, it will take 28 days.
What does this mean?
Indicating if the fund is ever required to exit its positions in the market, it would now take even longer. In simple terms, the liquidity risk has increased.
So, what does the overall trend suggest?
It indicates liquidity has reduced, liquidity risk has increased and mutual funds are now taking longer to process redemptions.
Stress test results of three small cap funds we discussed highlight the fund’s liquidity profile, in other words, how quickly a fund can convert its assets into cash under stressed market conditions.
For investors, this is valuable information. It helps you understand the level of liquidity risk in the fund. If it takes longer to liquidate assets, it means the fund may struggle to meet redemption requests during volatile markets, increasing the overall risk to your investment.
Redemption Timeline for 25% and 50% of ₹100 Crore AUM
| Scheme Name | 25% Redemption (2025) | 50% Redemption (2025) | Days to Redeem ₹25 Cr | Days to Redeem ₹50 Cr |
|---|---|---|---|---|
|
Aditya Birla Small Cap |
4 days
|
7 days
|
4
|
7
|
|
Axis Small Cap Fund
|
13 days
|
25 days
|
13
|
25 |
|
Bandhan Small Cap
|
5 days
|
10 days |
5
|
10 |
|
Nippon India Small Cap |
18 days |
36 days |
18 |
36 |
|
DSP Small Cap |
24 days |
47 days |
24 |
47 |
|
HDFC Small Cap |
28 days |
57 days |
28 |
57 |
What the Data Tells Us
Aditya Birla Small Cap Fund has the highest liquidity, it can process a ₹50 crore redemption in just 7 days. In comparison, HDFC Small Cap Fund takes around 57 days to process the same amount, that is over 8 times longer.
Funds with higher liquidity are generally safer because they can handle redemptions more quickly. These funds tend to have some exposure to mid or large cap stocks, which might slightly reduce potential returns.
On the other hand, funds with lower liquidity, which invest heavily in small and micro cap stocks, may offer higher returns but they carry greater liquidity risk during market stress.
Suppose ABC Small Cap Fund has an AUM of ₹100 crore. If its stress test shows it can redeem 50% (₹50 crore) in 30 days, that might seem manageable.
But now consider XYZ Small Cap Fund with an AUM of ₹1,000 crore. For this fund, a 50% redemption means ₹500 crore and selling that amount of small cap stocks is far more difficult.
Smallcap stocks generally don’t trade in large volumes every day. If a particular stock has a daily trading volume of just ₹2 crore, a fund trying to sell a ₹500 crore position will face huge challenges. The fund manager might be forced to sell at much lower prices, leading to price slippage, where the value drops because the market can’t absorb such large sell orders easily.
Even if a fund shows a short redemption timeline in the stress test, it doesn’t guarantee real world safety if its AUM is very large and its portfolio is full of illiquid small cap stocks.
60-Day vs. 15-Day Liquidity Ratio: What It Means
Now, let’s try to understand what liquidity ratio tells us and why it matters.
This ratio indicates how quickly a mid cap or small cap fund can fulfill redemption requests during a market downturn.
If a fund takes 60 days to liquidate 50% of its portfolio, it is considered less liquid compared to another fund that can do the same in 15 days.
- What does 60 days indicate?
- It signals high liquidity risk.
- The fund likely holds a large portion of its portfolio in illiquid small cap stocks.
- If the fund has a high AUM in a relatively small cap, selling large volumes quickly becomes a challenge.
- Funds that are fully invested with little or no cash reserve may struggle to meet sudden redemption requests.
- If investments are concentrated in just a few sectors or companies, the lack of diversification further increases the risk.
- What does 15 days indicate?
- This suggests low liquidity risk.
- The fund manager may have a higher allocation in cash or in larger, more frequently traded companies.
- Stronger liquidity filters are applied during stock selection.
- A lower AUM allows redemptions to be processed more efficiently.
- The fund is often more diversified across market caps, helping reduce overall risk.
- If you're investing for the short or medium term, a longer redemption timeline may point to a liquidity mismatch, meaning the fund may struggle to quickly return your money during high redemption periods.
- However, if you're a long term investor and trust the fund’s overall strategy, then you should not worry.
- A 60 day redemption window doesn’t mean the fund is risk or not good. It simply suggests that in a large scale redemptions, investors might need to wait longer to access their money.
Investor Categorisation: Who Should Be Concerned?
- Short term investors: You should be cautious. If your small or mid cap fund takes 40 to 60 days to process exits during a stress scenario, it might not be the right choice for your goals.
- Medium term investors (2–4 years): A cautious approach is wise. Try to stick with funds that have a liquidity period of 20 to 30 days or less.
- Long term investors (5–10 years): If the fund invests in fundamentally strong companies, then a slightly longer liquidity period may be acceptable.
To simplify things, you can follow this basic framework:
- Red Zone (40+ days): High risk category, suitable only if you’re investing with a long term horizon.
- Yellow Zone (20–40 days): High risk category, suitable only if you’re investing with a long term horizon.
- Green Zone (Less than 20 days): High risk category, suitable only if you’re investing with a long term horizon.
Where to Check Stress Test Results?
Knowledge is power, but only when used at the right time and in the right place. So, how can you check the stress test results of your mutual fund? Here’s a simple step by step guide:
- Visit the official AMFI website: www.amfiindia.com
- On the top navigation bar, click on the “Disclosures” section.
- From the drop down menu, select “Risk Parameter.”
Or you can go directly to this page:
https://www.amfiindia.com/riskparameter
Once you’re there, search for your specific mutual fund. Check how many days it would take for your fund to fully liquidate under stress. You can also compare this with other similar funds to understand whether your fund’s liquidity is stronger or weaker than the industry average.
How AMCs Manage Redemptions During a Real Crisis?
Here are some common strategies AMCs use:
- Cash Buffers: Most AMCs maintain a small percentage of cash reserves in their smallcap and mid cap funds. This buffer helps them meet sudden redemption requests without having to immediately sell off portfolio assets.
- Staggered Redemption Process: During high stress, AMCs may stagger redemption payouts. This means not all investors are paid at once. As per SEBI guidelines, mutual funds are allowed a few business days to process redemptions, helping reduce pressure on the fund.
- Swing Pricing Mechanism: Some funds apply swing pricing. When there's a large redemption, the fund slightly adjusts the NAV. This protects the remaining investors from bearing the cost of others exiting the fund.
- Side Pocketing: In extreme situations where a particular stock becomes completely illiquid, AMC can move it into a side pocket. This means the troubled asset is separated from the rest of the portfolio, allowing the fund to continue managing the remaining assets normally.
Final Words
So, that’s the complete picture behind the Stress Test for small and mid cap mutual funds. These stress tests are a valuable tool introduced by SEBI to protect investors and assess how well fund houses can handle uncertain market conditions.
If your portfolio is heavily tilted toward small cap funds that have shown weak performance in the stress test, it might be wise to consider rebalancing a portion of your investments.
Also, make it a habit to review these results from time to time, because a fund’s liquidity profile can change as its size increases or as market dynamics evolve.
Happy investing and thank you for reading!
Disclaimer:
This website content is only for educational purposes, not investment advice. Before making any investment, it’s important to do your own research and be fully informed. Investing in the stock market includes risks, and you should carefully read the Risk Disclosure documents before proceeding. Please remember that past performance doesn’t guarantee future results, and due to market fluctuations, your investment goals may not always be achieved.
