The first round of the mutual fund stress test is over. The capital market regulator, Securities and Exchange Board of India (Sebi), had directed all mutual funds to assess their liquidity, and how liquid their underlying portfolios really are. The first round of results showed this: It would take an average of about 6 days for mid-cap funds to liquidate 50 percent of their portfolios and about 14 days, on average, for small-cap funds to liquidate 50 percent of their portfolios, if equity markets were to collapse badly and investors rushed for redemptions.

Sebi asked MFs to calculate the time required to liquidate 50 percent and 25 percent of portfolios, after removing the bottom 20 percent of portfolios based on scrip liquidity. The main reason for the 20 percent exclusion is that the stress test is primarily for scenarios of 25 percent or 50 percent redemptions. Hence, the most illiquid part has been ignored. Fund managers usually prefer selling high-liquid stocks to illiquid ones during an adverse sell-off. Typically, those illiquid stocks are microcaps that can turn multibaggers. They are picked with care and backed by good research. They were identified at an early stage of their business cycles and the fund managers are likely to hold for the long term, till they provide the desired returns.