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Pakistan’s emerging markets status opens up new investment avenues for mutual funds

Last year, Morgan Stanley Capital International (MSCI) put Pakistan in Emerging Markets index (EM) from frontier market index (FM). The country was dropped from the MSCI Emerging Markets Index when it imposed a floor on the market during the financial crisis in 2008. The flooring trapped local and foreign investors for several months. The liquidity in the market got a boost last year with the MSCI’s announcement. The average daily value of trades stood at about $200 million in December 2016, which was almost double from a year ago. Since 2008, the market witnessed different reforms including demutualization in order to regain the trust of investors and deepen the investor base. Under the divestment policy, the Pakistan Stock Exchange (PSX) would now offer another 20 percent (160 million) shares to the general public within six months of the completion of acquisition process by the strategic investors.

The country’s re-entry into EM index was a strong bullish event for the stock market, as it has brought its perceived risk premium down in front of foreign investors. The emerging market index is also followed by a much larger number of investors and has several times more funds than frontier market participants. The re-entry into EM index triggers a significant re-rating of the Pakistan Stock Exchange (PSX). The reclassification is expected to attract sizable net foreign inflows. Over the first half of 2016, the PSX rallied as excitement over the country’s re-inclusion into the MSCI EM index drove valuations higher. To the foreign investors, Pakistan has been be grouped with the likes of China, India, Brazil, Russia and the UAE. It is worth remembering that Qatar and the UAE markets rallied more than 40 percent in the year after the announcement of their entry into the emerging market status in 2013.

The capital market provides the people with the investment opportunities and the companies to raise funds for expansion and development for further investments. Though the government has an important role to play in shaping the legal, institutional and business environment but major responsibility rests with the corporate sector to achieve a higher level of corporate governance. The high standards of corporate integrity and excellence are of key importance for the development of any capital market. The merger of Karachi Stock Exchange (KSE), Islamabad Stock Exchange (ISE) and Lahore Stock Exchange (LSE) is expected to prove beneficial for the growth and development of the country’s stock market. It would help strategically focus Pakistan’s developing capital market including expanding the investor base. This has also enhanced governance and transparency of the capital market.

INVOLVEMENT OF MUTUAL FUNDS

The prospects for growth of the country’s mutual fund industry brightened after the country’s re-entry into EM index last year. NAFA Stock Fund was the top performer with a return of 14.24 percent in the first six months of 2016, followed by Lakson Equity Fund returning 12.19 percent and First Capital Mutual Fund returning 11.64 percent, which is the only fund in the top five with assets under management of less than Rs1 billion. Lakson Equity Fund was the least volatile at 12.47 percent amongst the top five performers over the first half of the last year, which means it exhibited the most consistency or stability in its returns, while NAFA exhibited the highest volatility with 13.84 percent. Volatility is the measure of risk associated with a stock. The experts interpret lower volatility as the asset manager took on less risk to generate return while higher volatility leads to more variability in returns, more fluctuation in stock price and increased uncertainty for investors. The experts see more risk as a greater chance of making as well as losing money.

There are 29 Islamic open ended funds 18 voluntary pension funds and 1 closed ended fund in the country. The Islamic funds constitute 12 percent of the overall fund management in Pakistan. The country currently has the total assets worth Rs58 billion under management of Islamic mutual funds. Islamic funds industry is still at its initial stage. Presently, the country has all types of funds available on the Islamic side. These funds include money market, equity, sovereign, corporate fixed income, capital protected and index tracker. Fixed income, interest bearing bonds are not permissible in Shariah. Islamic funds have actually provided a window to a number of individuals, who were previously reluctant to invest because of their religious beliefs.

The Securities and Exchange Commission of Pakistan (SECP) regulates the asset management companies and ensures safety of the money deposited in mutual funds. At present, there are about 16 companies that manage 32 Islamic mutual funds in the country. The asset management companies are required to appoint Shariah Advisor, who reviews the working of the Islamic mutual funds and provides guidelines and criteria for investments. The Advisor’s guidelines are binding on the fund manager.

Islamic mutual fund industry has witnessed a phenomenal growth all over the world particularly in the Islamic world. About $1.34 trillion of assets are being managed according to Islamic investment principles, according to Global Islamic Finance Report 2012. Such principles form part of Shariah, which is often understood to be ‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam.

Islamic funds industry has yet to evolve develop and grow with new market players in Pakistan. Islamic principles encourage entrepreneurship in productive sector, or in other words they enhance productive capacity of the economy. The experts, however, believe that there remains entrepreneurial risk, which can only be eliminated at the cost of compromising the basic distinctions of Islamic economic principles. There is a dire need for establishment of institutions, which could promote entrepreneurial culture. There is, however, a long way to go forward in this regard. There is still a dire need to work for expansion of client base of Islamic funds management industry in the country.

There are no two opinion on that the blue-chip stocks specifically included in the MSCI Emerging Markets Index will drive market returns, a diversification, however, across large-cap, mid-cap and small-cap companies is direly needed. It depends on the local mutual funds that how they lure the incoming capital and investors looking to diversify across this high-growth market. The prospects are bright for the local mutual funds to continue to provide sizeable returns and become an attractive destination for the investors.

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