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A brief review of investments made by mutual funds industry in Pakistan

Basic mind set of any type of Investor is to manage the risk and maximize the returns. The common phenomenon in managing the risk is diversification or, in other words, not putting all the eggs in one basket. The diversification requires choosing which baskets to put your eggs in; and most importantly how much? This question and lack of expertise to invest in the financial markets gave birth to the mutual funds. The financial market experts found a gap and translated it in to the win-win situation for those who doesn’t exactly know when and where to invest and minimizing the risk through efficient management of funds through large portfolios, having enough capital to divest.

A portfolio can have the possibility of reducing the risk through diversification. The phenomenon of mutual funds is quite simple that all the small saving holders put their money in one kitty (Fund Managers) and then a kitty with a sizeable worth can afford to invest in riskier and non-riskier financial market products managing a moderate return or even higher returns from the market returns. Instead putting all eggs with a small saving in one basket and exposing to high risk of breaking all the eggs it is good alternatively putting the investment at very low risk and low returns by investing in the low risk securities.

The mutual funds industry, which started out in the 1960s with two state‐owned funds, National Investment Trust (NIT) and Investment Corporation of Pakistan (ICP), is now a thriving segment of the financial sector, with an astonishing growth in both numbers and volumes, particularly since last 10 years. Mutual Funds, leading the NBFI sector with an average growth of more than 6 percent in the last three years, have closed the year with Net Asset Value (NAV) of PKR 490 billion. Shariah-compliant funds and pension funds have gained increasing popularity as reflected by their share in funds market and addition of 20 new such funds in FY16. Pakistan’s first Real Estate Investment Trust fund (REIT) has also been launched on June 12, 2015.

Real Estate Investment Trust (REITs) is a mutual fund that invests in a pool of properties/mortgages bundled together and offered as a security in the form of unit investment trusts. These units can then be traded on stock markets. Each unit in a REIT represents a proportionate fraction of ownership in each of the underlying properties/mortgages providing its holders a simple way to invest in real estate without the cost or illiquidity associated with owning a property directly. There are two main types of REITs: equity REITs and mortgage REITs (mREITs). Equity REITs invest in real estate by acquiring properties and developing or renting them. Mortgage REITs invest in the debt required to finance real estate, including mortgage loans and Mortgage Backed Securities (MBS).

The mutual fund industry is also no exception to the effects of easing of monetary policy. As the interest rates started to decline, money market instruments became less and less attractive for the investors. The outflow from money market funds has been large enough to more than offset the inflows observed in the rest of the funds categories. Consequently, the sector has observed overall increase in net redemptions. In light of the prevailing low interest rate scenario, investor interest is expected to move further towards high yielding equity funds. Some volatility may persist in the equity market in the near term but equities are expected to perform better relative to money market over the medium term. Investors with relevant risk profiles and investment horizons may profit from investing in the equity funds category while yield on debt instruments are expected to remain subdued due to soft inflation outlook.

State Bank of Pakistan (SBP) has also allowed mutual funds to make overseas investments up to 30 percent of the aggregate funds mobilized (including foreign currency funds) subject to a cap of US$ 15 million, whichever is lower. Prior approval of SBP is required by a mutual fund seeking to invest outside Pakistan. In order to manage associated risks, SECP generally requires fund managers to observe certain conditions vis‐à‐vis international investments. The permission to invest abroad has been welcomed by the mutual funds sector as it would enable them to diversify investments outside Pakistan.

An encouraging development in the mutual funds sector is the increasing diversity of categories of funds offered for public subscription which are as follows:

  • Growth Fund
  • Asset Allocation Fund
  • Money Market Fund
  • Tracker Fund
  • Fund of Funds
  • Income Fund
  • Balanced Fund
  • Equity Fund
  • Sector Fund
  • Islamic Fund

Mutual funds continue to remain an important alternate avenue for investments due to their comprehensive suite of products with multiple investments classes like equity, money market and income funds. However, despite rising share of retail investors in funds market, their share is still low by international standards where retail participation is, generally, to the tune of 80 percent. Mutual funds are, therefore, a long way away from establishing themselves as a worthwhile alternate savings avenue in Pakistan as is the case internationally. Developments in the regulatory and operating environment indicate a strong potential for the mutual funds sector to continue its growth momentum albeit the challenges faced by the sector need to be addressed expeditiously.

Apart from direct competition from commercial banks and NSS instruments, returns offered by mutual funds is also effected by indirect cost of taxes and fees levied at the fund level. Expense ratio has been capped according to the type of fund. Management fee has further been reduced to limit the maximum expenses that can be charged to a mutual fund to improve investors’ return. Banking sector further presents a challenging competitor not only in terms of funds mobilized but also with regards to outreach to the general public through their extended branch network. Further, lack of awareness about investment options among the public coupled with expenses at the fund level, which places direct investments at an advantage, continue to constrain the emergence of mutual funds as a viable conduit for retail savings.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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