Mutual Funds adopt cautious stance on closing auction

As the Indian stock market adjusts to the newly introduced Closing Auction Session (CAS), mutual fund managers are treading cautiously, opting to finish trades before 3:15 pm rather than participate in the recently launched end-of-day auction. The new mechanism, designed to determine closing prices through a short auction window, has attracted scrutiny following a period of pronounced volatility and erratic price moves, particularly during its initial sessions.

During the system’s first two days, benchmark indices experienced sharp swings, with the Nifty surging nearly 150 points in the closing auction window on Tuesday’s weekly expiry, after a similarly abrupt rise in the previous session. The abrupt end-of-day moves have left market participants unsettled. The mechanism has also widened the gap between cash and derivatives prices, highlighting challenges associated with the initial phase of implementation.

Market dealers and fund managers note that the heightened volatility coincides with low participation in the auction, producing a "chicken-and-egg" dilemma. Many institutions remain on the sidelines, awaiting greater stability, even as that very stability depends on broader participation. “It is still a bit complicated and we need to see how it plays out. For now, we are doing our executions before 3:15 pm,” a mutual fund executive told Moneycontrol, requesting anonymity. Another fund dealer described institutional execution as more challenging under the auction approach, explaining that all orders are now submitted without real-time price discovery, increasing uncertainty. “We have to place our orders without knowing the final equilibrium price, and execution depends on available matching,” the dealer said.

The immediate effect of thin volume has been heightened price volatility and increased difficulty in executing large institutional orders without moving prices or accepting suboptimal fills. “Volume is very low right now, which has resulted in high volatility. I don’t know whether it is manipulation or not, but it has certainly led to sharp price movements,” said another dealer. Several fund managers reported attempts to participate in the auction, but noted limited success in executing trades at desired price levels due to the lack of liquidity.

Despite the turbulent rollout, institutional investors acknowledge that the long-term rationale behind the closing auction remains sound, particularly for passive products. Index funds, which currently trade before the auction and can end up with execution prices diverging from the official close, could eventually benefit from improved alignment, reducing tracking error. R. Sivakumar of Axis Mutual Fund commented that such adjustments are to be expected whenever market structure shifts. “The initial volatility is because liquidity is still limited and the market is adjusting to a new mechanism. If you are able to get everybody to trade at one end-of-day price, it can increase liquidity, especially for relatively less liquid securities,” he said.

Currently, the closing auction scheme is limited to F&O (futures and options) stocks, which are among the more liquid instruments. Sivakumar suggested that expanding the mechanism to a broader universe would yield even greater benefits, improving price formation and execution for both passive investors and those trading less actively.

For now, however, most fund managers remain on the sidelines, preferring to wait until a critical mass of participants embraces the new system. They anticipate that, as liquidity builds and more players enter, the closing auction will steadily begin to deliver on its promise of improved price discovery and reduced volatility at the market close.