MUTUAL FUNDS INDUSTRY, GOVT HAVE TO RESCUE SMALL INDIVIDUAL INVESTORS
Interview: Mr Etrat Rizvi, CEO NAMCO
KHALIL AHMED, Senior Correspondent
Apr 02 - 08, 2007
Mr. Rizvi possesses a unique and rich experience of working in private and public sectors in the fields of banking, development financing, manufacturing and utility as well as regulatory organizations. He has played a key role in the development of the Code of Corporate Governance, Insurance Rules, Private Pension System, NBFC Rules, Prudential Regulations for NBFCs, Code of Conduct for credit rating companies, etc. His last assignment was Commissioner SECP. He has served as the Chairman of The Bank of Khyber, Managing Director of National Development Leasing Corporation and Managing Director of Paramount Leasing Ltd. He is presently the Director of Bank of Khyber and Pioneer Cement Limited and the Chief Executive of National Asset Management Company Ltd (NAMCO). Following are the excerpts of Mr. Rizvi's interview with PAGE.
PAGE: Please tell us something about your organization.
ETRAT RIZVI: National Asset Management Company Limited (NAMCO) is a non-banking finance company (NBFC) which was incorporated on October 27, 2005 as a public limited company under Companies Ordinance-1984. The associated institutional sponsors include First National Equities Limited, First Pakistan Securities Limited and Switch Securities (Pvt.) Limited. Other associate companies of NAMCO comprise Trust Leasing and Investment Bank Limited, Pioneer Cement Limited, MCD Pakistan Limited, First Tameer Limited and First Florance Developers (Pvt.) Limited. NAMCO enjoys strong backing and support from its well-established sponsors which have a sound market reputation. The sponsoring institutions hold a decent track record of sharing their profitability with their respective shareholders through decent payouts. The aggregate equity and assets of the sponsoring institutions stand at PKR 2.20 billion and PKR 6.00 billion, respectively. Similarly the individual sponsors hold a sound profile of professional achievements and a reputation for integrity. They are committed to implementing the principles of corporate governance and safeguarding the interests of the stakeholders.
NAMCO has been licensed by the Securities and Exchange Commission of Pakistan to undertake the management of open-ended and closed-end mutual funds.
PAGE: Many people find surplus funds at their disposal but there are not many areas to find profitability, yet risk-free modes of investment are available to them. Please comment on it?
RIZVI: It is true that many people have surplus funds available with them but are not able to find profitability, yet low-risk investment avenues are available. Although the mutual funds provide various types of investment options that can match investors' risk appetite with the returns, there is a general need of investor education. As higher returns carry higher risk, therefore, based on risk-return trade-off; different kinds of funds are available in the market. There are equity funds which have high risk but can provide high returns. On the other hand income funds provide low returns while entailing low risk. The third type of funds is the balanced funds which are a combination of both equity and fixed income. Liability based classification of mutual funds comprise open-end fund and closed-end funds. Certificates of open-end funds are redeemed at the asset management company itself at the redemption price which is linked with the net asset value (NAV). The redemption price is normally lower than the NAV certificates of the closed-end funds which are sold and purchased through the stock exchange. Investors can select funds by evaluating various choices based on their financial objectives and tolerance to risk. Taking on some risk is actually the price of achieving return. So in order to get reward based on risk, one cannot simply evade all risks. Instead the goal should be to find an investment avenue that not only provides a stream of income but also a good sleep as well.
PAGE: What is the market response to your products?
RIZVI: NAMCO has recently launched its first closed-end fund (NBF) which falls under Balanced Funds category. The main idea is to generate long term capital appreciation as well as current income by creating a balanced portfolio that is invested in a diversified portfolio of securities representing investments in the capital and the money markets of the country. Performance can be gauged by considering the fact of taking the bold step to come up with a closed end fund since most of the recently launched companies have been launching open end funds only - reason being that the closed end funds usually trade at a discount to the NAV and therefore investors are reluctant to invest in it. NBF was launched with a capital of Rs. 1 billion. The launch of second fund is just around the corner. This will be an open end fund for those individuals who are somewhat risk averse but seeking a way to enhance their realized rate of return beyond the prevailing bank deposit rates, since mutual funds can take positions in certain assets which small investors cannot do themselves. For example, government treasuries and bonds may not be easily available to small investors, but through mutual fund investment small investors may take up positions in these assets.
PAGE: Do you think that investment in mutual funds is a kind of hedge against inflation?
RIZVI: Studies have indicated that common stock is the best hedge against inflation. Mutual funds investing in stocks do provide a hedge against inflation in the long run. Next are balanced & fixed income funds that also provide inflation protection.
Currently short-term bank deposit rates in Pakistan are in the range of 5-6% p.a. In comparison, the inflation estimates for FY07 is around 6.5%. Therefore, investments in short-term bank deposits in Pakistan return a negative inflation adjusted return. Short-term investments in equity and even in balanced funds can result in lower than expected returns, however, this is not so in the case of fixed income funds. Corporate bonds/TFCs returns in Pakistan are around 10% p.a. However, fixed income is an illiquid asset class in Pakistan and minimal inflation adjusted returns do not justify the liquidity risk taken. Fixed income mutual funds generally provide a highly liquid investment option to investors, providing a return mostly in excess of 10% p.a., thus providing a 'best of both worlds' to their investors. On the long-term holding periods, equity market has the best potential as far as profitability is concerned, which is why long-term investors can find equity & balanced mutual funds most attractive.
PAGE: Please tell us something about the mutual fund industry's investor-base expansion over the years.
RIZVI: Mutual funds industry is growing at a very rapid pace in Pakistan with around 30 fund management companies which are managing over 35 open-end and 23 closed-end mutual funds, both in the public and private sectors. The total net asset value of mutual funds in Pakistan was at Rs.173.689 billion as reported by the Mutual Funds Association of Pakistan (MUFAP) in September 2006, which is a 40% increase since September 2005 (NAV:124 billion). The growth over the years is evident from the table below.
(RS. IN BILLION)
The ratio of investment in mutual funds is low as against bank deposits on the regional level, which shows that there is a tremendous potential for growth in the sector.
The public in Pakistan is generally unaware of mutual funds and their capacity as investment vehicles. Mutual fund presentation and density are both quite low in Pakistan. Total number of certificate holders including corporates, multiple holding in different funds and the individuals is estimated at around 1,75,000 only.
PAGE: Many international companies are planning to enter the Indian mutual fund sector. What is the situation in Pakistan in this regard? The prudential ICICI mutual fund is a joint venture between the Prudential PLC, UK's leading insurance company and the ICICI bank, India's top financial institution. Do we have such a joint venture in our country?
RIZVI: Foreign companies are already present in Pakistan through joint ventures with local companies. It is pertinent to point out that SECP had a requirement of joint venture with foreign company for the award of AMC license, this requirement was later on dispensed with. Due to the growth in the banking sector, we have lately seen foreign interest in acquisition of Pakistani banks while many of the local banks have already set up their AMCs and IACs. Foreign interest in mutual funds is therefore likely to be more pronounced in the future.
PAGE: By December 2005 the number of operating funds had jumped from just a handful to 42. How many funds are expected to come by the end of this year?
RIZVI: Mutual funds have seen a growth in recent years specially after the framing of non banking finance companies (Establishment and Regulation) Rules 2003 that paved the way for floatation of open end funds by the private sector, as well as floatation of mutual funds under a trust structure.
NO. OF FUNDS
In order to break even the mutual fund managers have to have a minimum size. I am of the view that the number of asset management companies as well as number of mutual funds will increase in the near future.
PAGE: It is being said that bulk of the growth in mutual funds has come from weighty investments made by a few giant financial institutions, not a smattering of savings from thousands of doctors, shopkeepers and barbers ... that is actually the stuff of mutual funds. Real growth will only be seen when it comes from retail growth. Please Comment!
RIZVI: Since financial institutions' investments sometimes act like hot money, the sudden withdrawal of funds can actually hamper the performance of the open-end mutual funds when they are forced to liquidate some investments due to large redemptions by financial institutions. Closed end funds, however, do not face the same limitation. For the real growth, however, the masses' participation is necessary. As mentioned earlier this industry has to increase its outreach to the general public to achieve its basic objective.
PAGE: Could closed end funds be converted into open end funds. If yes, what could be the benefits?
MR. RIZVI: Rule 61 of the NBFC Rules-2003 provides a way for conversion of closed end funds into open end funds. Under the aforementioned rule, the requirements for conversion consist of a resolution passed by the majority certificate-holders of the closed-end scheme and subsequent approval by the SECP. Since closed end funds normally trade at a discount to their NAV in the secondary market, therefore, investors are reluctant to invest in closed end funds. The option of conversion to open-end fund provides an exit mechanism for the investors whereby they can buy or sell the units directly from the AMC of the fund at the redemption price, after paying some fee.
PAGE: How do your funds manage to face the stiff competition posed by other funds? What strategy do you apply in terms of product differentiation?
RIZVI: Currently NAMCO has only one fund i.e. NAMCO balanced fund. We are in the process of launching other funds. NAMCO strives to stay ahead of the competition by formulating different portfolios which yield distinct returns. NBF has made investment in a range of asset classes as it holds a mixture of shares as well as fixed interest investments to generate sufficient cash inflows. Since the major chunk of the fund size has been invested in equities therefore a stringent effort has been made at our end to be better off in different market situations by choosing an assortment of both high beta and low beta stocks. Our equity folder comprises two different portfolios of fundamentally strong stocks based on dividend yielding shares and growth stocks to achieve profitability through capital gains and dividends. Furthermore, we constantly gauge our fund's performance by carrying out a benchmarking assessment of our NAV vis-a-vis competitors and KSE 100 index. In view of our commitment to good corporate governance and transparency; we provide daily NAV of our closed end fund though it is not a requirement under NBFC rules. We believe that discount between NAV and market price of closed-end funds will reduce considerably if all closed-end funds start providing daily NAV on voluntary basis.
PAGE: How much foreign investment has been made in mutual funds industry and how do you see future of foreign investment in this sector?
RIZVI: 700% growth in FDI over a period of just 4 years affirms the exponentially growing foreign interest in Pakistan as a developing economy offering exceptional returns. Furthermore the return of Pakistan's capital market over different time periods has been much more consistent as compared to other regional markets. Daily traded value of Pakistan's capital market is among the highest when compared to similar markets, thus making it one of the most liquid markets in the region. This highlights depth of investment for potential investors. However, foreign investments are very few particularly in Mutual funds and are short in nature.
PAGE: What do you think the government should do in order to help the mutual funds sector perform even better?
RIZVI: While there is tremendous potential in the mutual fund industry; there are certain steps which are essential to facilitate the growth. This facilitation is not the sole responsibility of the government. This responsibility is to be shared by the market players (mutual funds), stock exchanges, brokerage community and the government. The recent permission to corporates allowing investment in NSS is a reversal of policy. It is interesting that NSS has opened the window for corporates and the mutual funds also catering mainly to corporates, the retail clientele is being deprived to receive the much needed attention. The mutual fund industry and the government have to come to rescue the small individual investors to achieve the socio-economic objective. NSS should be converted into Pakistan Saving Corporation as was announced three years ago in the budget speech. A major initiative to be jointly taken by the government and the stock exchanges is to enlarge the number of listings on the exchange and also to encourage the listing of debt instruments which have shrunk in recent past. Perhaps a positive incentive needs to be provided through tax differential of listed and non-listed companies as was the case in the past.