Mutual Funds take wait-and-watch approach on closing auction amid thin liquidity
Fund managers are largely executing trades before the auction for now, saying broader participation is needed before the new framework delivers better execution and lower tracking error
The mechanism has come under scrutiny after triggering sharp end-of-day moves in benchmark indices and widening the gap between cash and derivatives prices during its first two trading sessions. On Tuesday’s weekly expiry, the Nifty jumped nearly 150 points during the closing auction window, following a similar late-session spike on Monday.
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Mutual fund managers are adopting a wait-and-watch approach towards the new Closing Auction Session (CAS), with many choosing to complete their trades before 3:15 pm as the market adjusts to the new framework and participation remains thin.
The mechanism has come under scrutiny after triggering sharp end-of-day moves in benchmark indices and widening the gap between cash and derivatives prices during its first two trading sessions. On Tuesday’s weekly expiry, the Nifty jumped nearly 150 points during the closing auction window, following a similar late-session spike on Monday.
Also read: Closing Auction System makes 0DTE options a riskier bet
While the initial volatility has unsettled market participants, fund managers and dealers say the current dislocations are largely a function of low participation and should ease as more institutions begin using the auction.
The Chicken-and-egg problem
“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. As participation gradually improves, it should become easier to execute trades at the prices we want. The intent behind the mechanism is good, and the market’s response should improve over time,” a mutual fund executive, who requested anonymity, said.
Another mutual fund dealer said the auction-based process has made institutional execution more challenging because orders are matched through an auction rather than continuous trading. “It is a little tricky to execute trades because it is no longer a free market. We have to place our orders without knowing the final equilibrium price, and execution depends on the available matching,” the dealer said.
According to the dealer, limited participation has amplified price swings during the initial days of the mechanism.
“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,” he said, adding that large institutional orders remain difficult to execute without influencing prices or compromising on quantities.
Another fund manager described the current phase as a “chicken-and-egg” problem. “Everyone is waiting for stability before participating, but stability itself will only come once more participants enter the market,” the fund manager said. The fund manager said the scheme participated in the closing auction on the second day but could not execute trades at the desired prices because of limited liquidity. As participation improves, the current price distortions are expected to diminish.
Long-term benefits possible
Despite the cautious start, fund managers agree that the long-term rationale behind the mechanism remains compelling, particularly for passive funds.
One fund manager said many index funds currently complete their trades before the closing auction window, resulting in tracking error because execution prices differ from the official closing price. Executing through the auction should help reduce that mismatch over time.
Axis Mutual Fund’s R. Sivakumar said some turbulence was inevitable whenever market infrastructure undergoes a significant change. “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. The mechanism brings everybody to a single price and reduces the tick-by-tick volatility that you see in less liquid stocks. The ability to execute at one price has a lot of value,” he said.
Sivakumar noted that the current framework applies only to F&O stocks, which are already among the more liquid securities, but said he would like to see the closing auction eventually expanded to a broader universe of stocks.
“I see value in the closing auction system. It improves execution substantially for passive investors, and I think it also benefits relatively less liquid securities. My expectation, or rather my preference, is that, over time, we have an auction mechanism for a much broader universe of securities than the limited list today,” he said.
For now, however, fund managers are choosing caution over participation. They expect liquidity to build gradually as more institutional investors, arbitrageurs and other market participants become comfortable with the mechanism, allowing the closing auction to deliver the benefits it was designed to achieve.