A Rs 5,000 crore equity fund holding 3% cash sees net outflows of 12% in a month while the market falls 25%. Show the forced selling, the impact cost on the least liquid third, and how index futures could have bridged the gap.

Cash covered Rs 150 crore of the Rs 600 crore; the other Rs 450 crore was forced selling, and it cost the investors who stayed about Rs 8.4 crore. Impact was Rs 3.90 crore, Rs 2.25 of it on the least liquid third, and the lag between the leavers' NAV and the sale prices cost about Rs 4.5 crore more: 26 basis points of what remained. Selling Rs 450 crore of index futures on day one and unwinding the stocks over fifteen days would have cut that to about Rs 1.8 crore.

From the cash first, then from whatever could be sold. A family that must find Rs 6 lakh in a month empties the savings account and then sells things, and the things it sells go for less than they were worth because it needs the money now. The fund had Rs 150 crore of cash, which covered a quarter of the outflow; the remaining Rs 450 crore had to come from selling stocks into a market already down 25%. Selling in proportion to the tiers, Rs 150 crore from each, keeps the portfolio's shape but forces Rs 150 crore through the least liquid names, the ones whose buyers vanish in a fall. The other choice, selling only the liquid third, costs less today and leaves the stayers with a portfolio that is 38% least-liquid instead of 33%, so the next redemption wave is worse.

Two costs, both invisible on the day. Impact: Rs 150 crore at 0.3%, 0.8% and 1.5% by tier is Rs 0.45, Rs 1.20 and Rs 2.25 crore, Rs 3.90 crore in all, more than half of it on the least liquid third. Slippage: the leaver is paid the NAV of the day the request lands, and the fund sells a day or two later; in a month the market fell 25%, an average gap of 1% is conservative, and 1% of Rs 450 crore is Rs 4.5 crore. Together about Rs 8.4 crore, 26 basis points of the Rs 3188 crore that remained. The leavers were paid before any of it was realised, so every rupee of it came out of the stayers' NAV.

By separating the two things a redemption forces the fund to do at once: cut market exposure today, and turn stocks into cash. On the day the redemptions land, the fund sells Rs 450 crore of index futures, which locks in the market level the leavers were paid at; it then sells the stocks over fifteen days at orderly impact, buying back the futures as the cash comes in. Futures cost about 0.05% each way, Rs 0.45 crore in total, and the orderly impact is Rs 1.35 crore, so the stayers bear about Rs 1.8 crore instead of Rs 8.4 crore. The slippage disappears because the hedge was on from the NAV date. What remains is basis risk: a mid-cap portfolio does not move exactly with the index, so the hedge is imperfect, and the fund needs margin cash and a derivatives mandate in its scheme document, to be confirmed.

Three things, before the next fall. First, hold the cash buffer in futures rather than idle: 3% cash with 3% of index futures on top keeps the fund fully exposed in normal times and gives it a hedge it can lift, rather than add, in a stress. Second, know the exit time of every holding: a fund that reports days-to-liquidate by tier will size the least liquid names so that a 12% outflow never reaches them. Third, look at the mechanisms that make leavers pay their own costs: exit loads inside a holding period, and swing pricing, which adjusts the NAV paid to leavers on heavy outflow days; swing pricing in India has been introduced for some debt schemes, so confirm whether and how it applies to an equity fund. The limit of this analysis: the impact and slippage figures are assumptions, and the honest comparison is with the Rs 1212 crore the market fall itself cost, which dwarfs them. The point is not the size but the direction: every rupee of it moved from the investors who stayed to the investors who left.