'It's unnecessarily spooking markets': Finsec's Sandeep Parekh picks on MF stress tests

Sandeep Parekh, founder of Finsec Law Advisors and former Sebi executive director, picked on the regulator's stress test even as small and mid cap stocks stare at their worst week in 15 months as mutual funds start disclosing results of tests to assess their resilience to sudden redemption pressures.

In a series of posts on X, Parekh said there was no scientific basis for the tests. "It assumes liquidity to be a constant at best and extrapolates the past into the future at worst. If liquidity actually vanishes in a particular stock, it can just vanish not in 6 days or 14 days or whatever other metric is used - it will vanish in a microsecond. Analysis by extrapolation may or may not work. Yes, liquidity is often higher with higher volatility - but it's not a given," he wrote. 

Top Indian asset managers may need between two to 30 days to exit a quarter of their portfolio of small-cap stocks, results of the stress tests disclosed by these fund houses showed. These funds would need one to 17 days to exit a quarter of their mid-cap portfolio, the results showed.

A delay in exiting holdings of such stocks could defer the return of funds to investors, who expect to receive their money back within two to three days, as per current industry practice.

"It can be a self-fulfilling prophesy...if you are trying to predict that the markets are over-valued and that liquidity can vanish...the prediction itself would dry liquidity and reduce prices," Parekh said, adding that it was not the "job of regulator to predict either market levels (no matter how well-meaning, even accurate) or liquidity (which can't be predicted).

"Markets have strong 2nd and 3rd order effects. Trying to control the immediate effect could impact other stocks, other economic activity etc. Best to stick to the philosophy of full disclosure and trust the process".