DIVERSIFICATION IN MUTUAL FUNDS
Mar 17 - 23, 2008
There has been a phenomenal growth in the mutual fund industry in Pakistan during the last 5 years. Since 2002 the number of mutual funds has grown from 12 to 50 in 2007 while the assets under their managements have risen from Rs 25 billion to about Rs 264 billion during this period. The way it is growing there are chances of its development to an international standard in a couple of years despite being comparatively, a late entrant in the field.
However Pakistan was the pioneer in the field in South Asia region when the first mutual fund was introduced with the public offering of National Investment Trust in 1962. It almost remained in a dormant position till 1990. Since then the mutual funds made remarkable growth. There is no denying the fact that, mutual funds are being perceived as an attractive investment vehicle by individual investors, internationally. This trend is highly pronounced in the developed markets such as USA and Europe. However, the developing economies including Pakistan are also no exception to this global trend.
The unprecedented growth seen in the industry is set to continue in the next term, as the NSS rates, even after their revision, still remain quite unattractive for investors. Majority of the open-ended funds distribute their dividends in terms of bonus dividends, which are tax-free. On the other hand, profit on bank deposits and NSS is taxable. An investor is subjected to withholding tax deduction of up to 10% for individuals, which in their case is the final tax liability, whereas in the case of corporation, the total tax liability can be up to 35%. This makes the return on banks deposits and NSS significantly lower than their stated rate of return. The asset management companies and investment advisors collectively need to educate and create awareness amongst the general public about this investment avenue, as the retail segment still remains largely untapped.
Mutual funds performance is one of the most frequently studied topics in investments area in most countries. The reason for this popularity is the availability of data and the importance of mutual funds as vehicles for investment in the stock market for both individuals and institution. In Pakistan, a few years ago mutual funds were simply broad-based investment instruments created to simplify the intricacies involved in investing in separate securities. Gradually they gained popularity as they provided a greater measure of safety through board diversification and the kind of top-notch professional management that is usually out of reach for the small investor.
Today, however, mutual funds are highly specialized and offer almost unlimited diversity. The types of mutual funds portfolios available run the gamut from conservative to aggressive, from stocks to bonds, from domestic to international portfolios, from virtually no-risk money market funds to high-risk options funds. The great variety of mutual funds available makes it possible to select a fund. There are two types of mutual funds, 1) closed-end fund and 2) open-end fund.
A closed-ended fund is a collective investment scheme with a limited number of shares. It has a fixed pool of money, which is collected when the funds is set up. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to heave the fund. On a micro level there are several types of mutual funds available in Pakistan.
MONEY MARKET FUND
Money market funds should be considered by investors seeking stability of principal, total liquidity and earnings that are as high, or higher, than those available through bank certificates of deposit. And unlike bank cash deposits, money market funds have no early withdrawal penalties.
GROWTH AND INCOME FUNDS
The primary objectives of growth and income funds are to seek long-term growth of principal and reasonable current in come.
The balanced funds are meant to generate income as well as long-term growth of principal.
The intent of an index fund is basically to track the performance of the stock market.
In sector funds, the portfolios consist of investment from only one sector of the economy. Sector funds concentrate in one specific market segment.
Specialized funds resemble sector funds in most respects. The major difference is most is the type of securities that make up the fund's portfolio.
In case of Islamic Funds, the investment made in different instruments is to be in line with the Islamic Shariah Rules. The funds are generally to be governed by an Islamic Shariah Board.
ADVANTAGES OF MUTUAL FUNDS IN PAKISTAN
Mutual funds have become popular in Pakistan because they offer 4 advantages:
* Diversification. A single mutual fund can hold securities form hundreds or even thousands of issuers, for more than most investors could afford on their own. This diversification sharply reduces the risk of a serious loss due to problems in a particular company or industry.
* Professional management. Few investors have the time or expertise to manage their personal investments every day, to efficiently reinvest interest or dividend income, or to investigate the thousands of securities available in the financial markets. They prefer to rely on a mutual fund's investment adviser.
* Liquidity. Shares in a mutual fund can be bought and sold any business day, so investors have easy access to their money. While many individual securities can also be bought and sold readily, others aren't widely traded. In those situations, it could take several days or even longer to build or sell a position.
* Convenience. Mutual funds offer services that make investing easier. Funds shares can be bought or sold by mail, telephone, or the internet, so you can easily move your money from one fund to another, as your financial needs change.
Despite the tremendous interest in mutual funds world wide, mutual funds did not catch the fancy of Pakistani investors until recently (on the academic side there are two recent papers on the role of corporate governance and mutual funds in Pakistan by Cheema and Shah (2006) and Saeed and Syed (2005). For a long time two government controlled organizations: Investment Corporation of Pakistan (ICP), which provided several closed-end mutual funds, and the National Investment Trust (NIT), which was an open-end mutual fund, were the only players in the game. However, by 2005 nearly 50 mutual funds were listed on the three stock exchanges of Pakistan. While many of them are new comers there are over thirty funds with at least ten years of price and dividend record and their performance can now be tested for market efficiency.
There are certain rules that govern the mutual funds in Pakistan. These are:
* Investment Companies and investment Advisors' Rules, 1971. (it governs closed-end mutual funds)
* Asset Management companies Rules, 1995. (it governs open-ended mutual funds)
These rules however only apply to private sector operated mutual funds and are not applicable to NIT and ICP mutual funds.