Earnings of mutual funds have improved due to higher dividend income as well as capital gains

Sep 29 - Oct 05, 2003

Development of a vibrant mutual funds industry is essential for a country like Pakistan, where the savings rates and number of equity investors is low as compared to other countries in the region. The mutual funds industry acquires more importance as small investors are investing in equities market. Since such funds are usually managed by professionals and have diversified portfolio, the investors in funds get comparatively better on investment. However, it has been noticed that the size of mutual funds in Pakistan has remained stagnant over the last five years.

Mutual funds were introduced in Pakistan in 1962 with the public offering of National Investment Trust (NIT) units. NIT is an open-end mutual fund, still operating in the public sector. Investment Corporation of Pakistan (ICP) was established in 1966, which subsequently offered a series of closed-end mutual funds, totaling twenty-six. Management rights of all the 26 ICP funds have been transferred to the private sector. Now ABAMCO and PICIC manage 12 and 14 of the ICP funds. Presently, 7 open-end and 35 closed-end funds are being managed by the private sector.

A closer look into the history of mutual fund industry, spread over 40 years, reveals some interesting facts. The first ever open-end fund, NIT, was established in 1962 in the public sector and remained the only such fund in the country for over 30 years. They kept NIT a virtual monopoly for decades. To guarantee growth in its portfolio, offer of 25% shares of every public limited company to NIT was made mandatory. While this practice helped in building NIT's portfolio, it also led to certain 'dead investments'.

Then came the establishment of ICP, again in the public sector, with the additional mandate to manage closed-end funds. Over the years ICP floated 26 funds, including SEMF. The portfolio of SEMF comprised of shares of state-owned enterprises listed at local stock exchanges.

In 1971, the government cleared the way for entry of private sector in the closed-end segment but denied the right to float open-end fund. It is understood that the regulators were not convinced that private sector could manage an open-end fund. However, the events that took place in seventies did not incite the private sector to venture into mutual fund management. Only one fund was floated in the eighties.

Within a short span of six years (1991-96) private sector floated 12 closed-end mutual funds. Keeping in view the receptivity of the concept of mutual funds the government notified the amended rules for efficient management of funds. However, most the mutual funds floated by the private sector posted huge losses in the initial years. ICP and NIT also experienced substantial erosion in profitability but the shock was of lesser intensity.

The subdued performance and slow growth of mutual funds sector can be attributed to a number of factors.

However, the biggest blame of the poor performance of mutual funds managed by the private sector goes to the regulators. According to a sector expert, "The regulators made the biggest blunder by allowing private sector to establish closed-end mutual funds."

Another problem affecting the profitability of most of the private sector managed funds was that these were floated at the time prices of most of the scrips was very high and bulk of the investment in equities. As the market suffered from prolonged bearish spell, value of portfolio eroded and heavy provisions had to be made against diminution value of investment.

Since most of the mutual funds were floated by brokerage houses, almost all of them indulged in day trading rather than selecting scrips based on economic fundamentals for investment. The most unfortunate part of the story is that most of the brokerage house 'parked' their bad investment in the mutual funds. All these activities added to the losses of private sector mutual fund and no investor was ready to invest in shares of closed-end mutual funds.

Most probably, the largest number of companies was floated during the bullish period of nineties. A large number of these companies were established either by the 'rent seekers' or the projects were not economically viable but mutual funds picked up the shares without examining economic fundamentals affecting profitability of these companies. As corporate earnings plunged did the mutual funds.

On top of every thing, dollarization of Pakistan's economy and offer of very high rate of return on government securities provided opportunities to earn risk-free and hassle-free return. Therefore, people preferred to invest either in dollars or government securities rather than initiating/managing any business.

With the revival of economy, end of dollarization and substantial decline in interest rates, corporate earnings have improved. Earnings of mutual funds have also improved due to higher dividend income as well as capital gains. This is evident from the dividend pay out by NIT and new fund managers foe ICP funds (PICIC and ABAMCO).