MUTUAL FUNDS INDUSTRY FACING CRISIS
Feb 09 - 15, 2009
In the present days, Mutual fund is supposed to be the most suitable instrument for long or short term investment. However, all investments in funds come with some level of risk.
A Mutual Fund is an entity that pools the money of many investors and the people who buy shares of a mutual fund are its owners or called Unit Holders. Professional investment managers who are responsible for investing this money into Mutual Fund Basics manage mutual funds.
Investments may be in shares, debt securities, money market securities or a combination of all these. These securities are professionally managed on behalf of the unit holders and each investor holds a pro rata share of the portfolio, i.e. entitled to on a pro rata basis, any profits when the securities are sold, but subject to any losses in value as well. Money is invested by corporate or institutions and individuals.
To establish an investment plan first step is comprehension of investments best suited to achieve the set goals of the investors. Investment in mutual funds can be successful by choosing the type of fund. All investments in funds come with some level of risk therefore, it is important to have realistic expectations about the risk.
A mutual fund makes money for its Unit Holders in two ways: dividends or capital gain (or rise in the value of each Unit). However, a fund can also lose money.
The advantage of mutual funds is that it makes investment simple, accessible and affordable for everyone. The advantages of mutual funds include liquidity, tax benefits, professional management, diversification, accessibility, security, as well as strict government regulation and full disclosure.
Every mutual fund has an independent investment objective and may have a different investment strategy to achieve that objective.
STRUCTURE OF FUNDS
There are two generic types of funds available in the market: Closed end and open end funds.
CLOSED END FUNDS
Closed end mutual funds are more like the stock of a listed company, a fixed number of whose shares are traded on an exchange. The shares of closed end mutual funds are priced at market value determined by supply and demand and are not priced at the fund's net assets per share value and thus may be traded below or above the net asset value. If the shares of a closed end fund are traded above the net asset value the fund is said to be trading at a "premium" and if it is traded below the fund is said to be trading at a "discount". A feature of closed end funds is that they can be converted into open end funds.
OPEN END FUNDS
The mutual funds are that which continually create new units or redeem issued units on demand. Open end mutual funds are also called unit trusts, because they are registered as trusts. An open end fund unit holder can redeem or purchase units at any time. Units are priced at their Net Asset Value (NAV) on per unit basis and its unit price is determined by the net increase or decrease in the share prices of the stocks that the fund owns along with any dividends and capital gains received. The units of an open end mutual fund can be bought directly or through the Asset Management Company.
The mutual funds are becoming more attractive and popular instruments of investments among the general public world over. The funds have been introduced years ago in the United States of America and Europe.
The three operational forces dominating the global financial system are: an increasing focus towards meeting client needs instead of product sales; an increasing emphasis on the alignment of operations to manage and mitigate risk and reliance on emerging, broad based intra-industry utilities for trade processing, settlement, funds transfer etc.
In spite of barriers, the forces of globalization and cross border flows are becoming strong. This has already started happening, whether one likes it or not. There is no alternative to this but "think global" albeit the trend to "act local" may continue in future.
This year cross border flows are likely to be around 5 to 6 trillion dollars of which over a trillion would pertain to investments in mutual funds. The aggregate size of world industry is $21 trillion as against the world's financial assets totaled around $120 trillion. Four years ago the size of the industry was about $14 trillion. The industry continues to innovate and develop products of differing risk-reward profiles, which are constructed to capture value in a variety of ways.
The developing economies, including Pakistan, are no exception to this global trend. It has been witnessed that mutual funds though form a comparatively small segment of the securities market in developing countries they have been still increasingly gaining the public attention and have grown phenomenally over the last decade.
The mutual funds industry of Pakistan has shown excellent performance, however, still is facing several challenges to overcome. Both absolute and relative size of the industry remains rather small by international standards, its management is uneven, its funding mostly comes from institutions i.e. not from retail investors, its IT endowment is weak, its human capital is poor and it has to contend with a shallow pool of investable assets.
The aggregate size of the local funds industry grew from Rs25 billion to Rs190 billion. The industry spreads over some 22 closed end and 61 open end funds that are managed by 30 asset management/investment advisors. Rs145 billion are in open end funds and the rest is in closed end funds.
The total assets under management are only 2 percent of GDP or 5.8 percent of bank deposits or 6 to 7 percent of market capitalization. As compared to India whose mutual fund industry is 6 percent of GDP, 13.4 percent of bank deposits and around 10 to 12 percent of market capitalization, whereas in the United States mutual funds are about 70 percent of GDP, over 150 percent of bank deposits and about 20 to 25 percent of market capitalization.
Although Pakistan had an early start with the setting up of NIT in 1962 and subsequently the ICP mutual funds for almost 40 years ago until 2002 the progress made was not remarkable. In fact, the industry suffered both as a consequence of poor management as well as Government intervention and the distortions thus induced. However, during the past five years, due to positive changes in Government policy and regulation, privatization and new entrants, the industry has shown major improvement and enlargement.
In a globalizing world, markets as supra-national entities are the best vehicles to promote peace between nations. The Pakistan mutual fund association has tried to explore possibilities of listing some Indian funds on the Karachi and Lahore stock exchanges. And reciprocally, some prominent Pakistani funds could have made a foray into the Indian market. If the effort were successful it could create direct linkages between the financial markets of the two countries. Presently, a number of Pakistani individuals are investing in the Indian stock markets through funds located in third countries, while direct link could benefit both the countries.
Answering a question that what should be done to enhance the mutual funds industry in Pakistan so that it can play its role of reinforcement the financial markets and serve as an effective channel for mobilizing resources and allocating them to productive uses, Muhammad Nasim Khan, Chief Executive Officer/Managing Director, Sigma Leasing Corporation Limited said if mutual funds managers are competent, they will know how to deal with difficulties and make progress but if they are not, they won't be able to handle problems, presently prevailing in the country.
Commenting on the issues confronting the industry Mr Nasim Khan said the solution of these issues on priority basis is in the larger interest of the industry. It would improve investor confidence and trust in mutual funds industry.
He further said the mutual funds industry of Pakistan is in its infant stage but the government has put a floor ban on Karachi Stock Exchange as well as on mutual funds too. This step has shaken the confidence of investors and created a crisis like situation.
He enumerated various main challenges like small size of the industry, lack of diversified products, lack of distribution network etc. He said that implementation of compliance and ethics is one such major challenge, which the industry is required to address on an urgent basis.
Talking about the present situation Mr Nasim said the SECP gave two proposals to Mufap. It proposed a forced roll over of six months for the second ticket sale with interest at flat rate of 10 percent per annum to be charged on a daily basis. Financee will be free to release the shares and settle the outstanding trades at any time during the six-month period.
Mark-to-market losses will be collected on a daily basis from financee and mark-to-market losses will include the daily simple interest at the rate of 10 percent per annum. Profit (if any) will not be released to the financees. According to the proposals, at the end of six months the sale contracts will be forced released and settled.
No further extension will be allowed. Pro rata share of the existing mark-to-market losses and VaR (value at risk) margin shares will be ring fenced and retained for the benefit of the CFS financiers who opt for this proposal until their settlements take place. If at end of six months, the financee defaults then normal NCCPL Default Procedure shall apply. If during the six months the financee broker defaults, normal NCCPL Default Procedure shall apply.
However, the mutual fund industry rejected these proposals and said that the regulator should improve upon the proposal that would be acceptable to all stakeholders. The Mufap requested the SECP to improve upon the proposal to make them acceptable to all stakeholders otherwise they will seek legal protection. They said that they might agree with changed proposal with the hair cut of 45 percent, forced roll over for four months and with the interest rate of Kibor+2 to 3. The investment in CFS is two percent of the total value of income funds.
Mr Nasim complained that mutual funds booked reductions in net asset values by up to 15 percent. It was due to SECP's directive to revalue Term Finance Certificates (TFCs) downward by 5 to 30 percent. The repricing of TFCs had different impact on different mutual funds. Those who had high exposure in TFCs have suffered more than others.
There were different opinions among the mutual funds executives about the SECP's move. The Mutual Funds disagreed with the "arbitrary move" by the SECP to reprice TFCs.
There was no reason for not revaluing the TFCs on the book when their value had actually fallen by 20 to 30 percent. The value has to come down in the time when distressed selling has started and mutual funds are finding it difficult to sell their holdings because there is no buyer in the market, he said.
The mutual fund industry has experienced remarkable growth and has been able to pay handsome dividend/return to its unit holders. The industry demonstrated exceptional resilience in the face of acute liquidity problem generally faced by the financial sector and continued to meet redemptions (over Rs80 billion in last six months) of its unit holders. In order to meet any eventuality in the future, the industry was in constant touch with the government of Pakistan, State Bank of Pakistan and SECP and as a result of these meetings, the government agreed to guarantee the 'A' rated TFCs held in the investment portfolio of income funds to enable them to raise liquidity from the banks.
The SECP took a counterproductive measure at a time when industry was in process of raising liquidity from a consortium of banks and an amicable solution was in sight, by issuing a circular to reprice TFCs, he added.
Decision to reprice all TFCs has been taken without consultation with the industry and it is in contradiction of the methodology as stated in SECP's Rules and Regulations.
He was of the view that the said circular is neither in the interest of the general neither public nor the unit holders, who will have to take unnecessary reduction in unit prices as a result of this decision.
As far as Mufap role is concerned it must take steps to ensure mutual fund managers performing their activities in investors' interests and remain both transparent as well as accountable. The aim should be that mutual funds get recognition as institutions that provide the vast majority of individual investors the most efficient and effective access to securities markets.
In developing countries, mutual fund associations are doing on their own to protect the investor, raise standards of corporate governance, improve disclosure standards, and curb the use of insider trading and other forms of market abuse.
Muhammad Nasim Khan
Chief Executive Officer/ Managing Director
Sigma Leasing Corporation Limited