Opportunities for small investors



Mar 01 - 07, 2004





The Mutual Funds sector has been growing in size and also attaining greater diversity of portfolio. The growth in paid-up capital may look substantial but the size is still too small as compared to international standard. The in-road made by the private sector and transfer of management rights of ICP managed funds to private sector has reduced the quantum of funds being managed by the public sector. More and more funds are being listed and contributing towards the growth of capital market.

A Mutual Funds is a pool of money set up for the purpose of investing in financial instruments according to its objective. It is a professionally managed investment company that offers investors through the issuance of Certificates/Units an array of benefits unique in the investment world. Typically there are two categories open-end and closed-funds. Mutual funds generate income from dividend received from its investment and capital gains.

Mutual Funds face two types of risks, system risk and non-system risk. The system risk primarily constitutes the country risk and market risk, which cannot be mitigated due to its very nature. In some cross border mutual funds this risk is minimized but cannot be eliminated completely. The non-system risk is the risk taken on the capability of the Fund Management Company to sure diligent and effective execution of a market-based investment strategy for optimization of returns.

Until beginning of nineties, mutual funds were the exclusive domain of public sector. NIT was floated in 1962 and ICP was established in 1966. NIT remained the only open-end fund for more than three decades. Over the years, ICP floated 26 closed-end funds only. During 1991-96 period 12 funds were floated by the private sector but all of them were closed-end funds. The regulators at that time did not consider private sector competent enough to manage open-end funds. However, the time has proved that it was an incorrect policy.

Over the last few years, as the market experienced 'over flowing liquidity' and interest rates declined. Particularly the return on National Savings Schemes was curtailed to reduce the GoP's debt servicing. This led to influx of savings to equities market at tremendous volume. While a large number of investors may have made large gains by investing in equities market, even larger number lost the life-savings. Simply because they did not have the complete insight of the market. The lack of knowledge is not exceptional to Pakistan, it is more or less a universal phenomenon. What could be the way out?

Globally mutual funds are considered an appropriate investment vehicle for small investors. This is evident from the size of mutual funds sector and the number of investors in such funds. One of the indicators is percentage of bank deposits invested the funds. In the USA, mutual funds are 125% of the bank deposits, it may be an exception. In India the size is about 15% of the bank deposits. As against this the level in Pakistan is as low as 5% of the bank deposits. The only encouraging sign is that it has grown from 3% to current level in last couple of years. There it can be said conveniently that the sector enjoys enormous growth potential.

However, one of the concerns is, will the investors face the similar situation that they faced in nineties. The immediate and categorical reply of the fund managers is No. They say that both the fund managers and the regulators have learnt a lot from past mistakes and are acting very cautiously at present. In early nineties, the regulators dished out licenses rather recklessly and also lacked competence to monitor. As against this, at present Securities and Exchange Commission of Pakistan (SECP) is autonomous body with qualified and knowledgeable personnel. Licensing procedure is very stringent and demands greater disclosure. Therefore, it is expected that working of funds would be monitored more effectively.

Another indicator of realization of market realities is the growing size of open-end funds. Some of the analysts say that managers of open-end funds have to be more vigilant simply because they have to announce unit price periodically, ranging from daily to weekly basis. The unit sale/purchase price is based on net asset value (NAV). Any reduction in NAV automatically reduces the unit price. The fear of higher redemption, in case of substantial fall in NAV, is always there.



Against this, there are more chances of price manipulation of shares of closed-end funds. Investors get information about the financial health of funds only when they received quarterly reports. On top of this. if an investor wish to sell the shares he/she gets a price which is based on demand and supply phenomenon. Whereas, an investor in open-end fund can redeem the units more conveniently.

Similarly the fund managers are now following better practices and acting more prudently in picking up equities for investment. One of the indicators is that in nineties fund managers bought scrips at earning multiple of as high as 22. Whereas, they are cautious at 10 times multiple. The historic earning multiple in Pakistan has been around the same level.

However, some of the analysts say that the probability of 'parking bad investment in mutual funds' is still a serious concern. They say that most of the funds have been floated and are being managed by brokerage houses. Therefore, probability of parking bad investment in closed-end remains high.

They also say that some of the mutual funds also take active part in day-trading. Since the market is bullish at present they have sold out some of the investments made in the past to achieve capital gains and diverted the funds to scrips offering growth as well higher earnings potential. The concern is that some of these scrips still face rather fragile economic fundamentals.

Whereas, the fund managers say, "We constantly review our portfolio and make regular adjustments as we cannot remain contended on a few scrips. We do follow dividend yield methodology but we also take into account dividend payment ability of the companies and payout track record. On top of every thing now the typical portfolio of a fund is balanced. The portfolio normally comprise of equities, debt instruments and some times also include investment in money market."

Some of the analysts also say that most of the funds do not have any contingency plan, in case of a fall out. This expression is based on the perception that the KSE-100 index will continue its upward movement. No one seems to be ready even to listen that the index may plunge one day. However, one should always remember an old say that any thing that goes up has to come down eventually.

In this regard it would be more appropriate to mention the various rationale being put forward and let the investors make informed decision. The first argument is that while the index has attained the present level, the investment in quality scrips is still justified on dividend yield parameter. The second argument is that a number of scrips were being traded at a discount to their fair value and the recent increase in their prices is based on the earnings potential. The third argument is that with the decline in interest rates, revival of the economy and increase in investment in new ventures per capita income of an average person has led to greater spending. The growth in profitability of companies belonging to FMCG and services sectors substantiate greater spending. On top of this, the GoP's policy of divestment of shares of state-owned entities and listing of new companies are providing additional impetus. Therefore, the equities market is expected to remain vibrant in the foreseeable future. Only an external event can lead to free fall. In such a scenario all the investors will be affected and mutual funds cannot remain an exception.


New fund are being launched and funds under PICIC and ABAMCO are being merged. The number of listed funds will be reduced but listed capital is expected to increased. The growth of sector can be gauged from the fact that in 1991 there were 23 listed funds with an aggregate capital of Rs 678 million. The number increased to 37 funds and quantum of listed capital exceeded Rs 6,805 million by September 30, 2003. Since then a number of funds have been listed and the recent quantum of listed capital touches Rs 8,490 million. The size of listed capital will further grow as more funds are in the pipeline.

Another encouraging sign is that the number of Sharia compliant funds is on the increase. Meezan Islamic Fund was floated recently and Arif Habib Investment has also signed an MoU with The Bank of Khyber to float another Sharia compliant fund. A Sharia compliant fund is a fund that does not invest in shares of companies drawing bulk of their income from Riba-based operations and/or undertake activities prohibited by Sharia.

It may look a little strange that commercial banks are providing the largest percentage of seed-money and/or actively and substantially participating in the Pre-IPOs of Sharia compliant funds. It is true that there are very few opportunities available to commercial banks for investing in Sharia compliant instruments. Therefore, the deliberate strategy to move away from Riba-based activity is a positive move towards elimination of Riba from the economy.

It is expected that further privatization, trickle down impact of macroecomic stability and revitalization of micro economy would lead too surge in conversion of SMEs into large corporations leading to higher market capitalization and the same would be reflected in the mutual funds sector size as well.

Growth of mutual funds sector, like any other sector of economy is the result of demand and supply. In general, the same factors that influence the demand for mutual funds also shape their supply. Other factors affecting the growth of mutual funds are status of tax laws and regulatory set up.


Over the last five years, Indian mutual funds sector has grown by more than 5%, which led to its current size of US$ 22 billion. Out of these assets 59% were contributed by open-end funds, 19% by open-end money market funds and the rest was constituted by equity funds, balanced funds and government securities. Primary driver of growth has been change in tax laws, establishment and redefining of regulatory procedures.