MUTUAL FUNDS: CHALLENGES ARE OPPORTUNITIES

Mutual funds are still in infancy but it is not a weakness at all, rather it should be seen as strength or a blessing in disguise.

SYED M. ASLAM
Apr 02 - 08, 2007

Challenges are opportunities and that is also true for the nascent mutual funds segment of the financial markets in Pakistan. Mutual funds have only started to scratch the surface of the immense potential that still remains untapped in the country. While it is true that mutual funds have a long way to go to become the mainstream investment option here as like elsewhere in the world the very fact that there are more mutual fund managers - many of whom are offering a range of diversified products - today clearly hints at the growth of mutual funds in the years to come.

The popularity of mutually funds to become one of the most preferred investment options worldwide can be attributed to the convenience attached to it because mutual funds are managed by professional fund managers who charge a small fee to help save investors the cost, energies and time otherwise needed to invest in stocks, bonds, real estate, government securities. In addition, MF usually offer attractive returns and are less risky compared to investing in stocks, real estate or gold. An added advantage of mutual funds is that they are also much more accessible to small investors who just cannot afford to cough up huge sums of money that is required to invest in much more volatile stock market.

Having said that let us come back to the challenges and opportunities or rather weaknesses and strengths of the mutual funds in Pakistan. The major detriments to the growth of the mutual funds in Pakistan could be summed up as acute lack of public awareness about the benefits that it offers to small investors, lack of education, acute shortage of an educated and specialized workforce including limited availability of professional and dedicated fund managers, absence of organized distribution network not only in suburban but also in urban areas in a country where the majority of the population of over 160 million still lives in villages and low per capita savings rate.

One of the major weaknesses that mutual funds are still in infancy is not a weakness at all. It should be seen a strength or rather a blessing in disguise. True that mutual funds are still in its infancy stage in Pakistan and true also that they are still in the process of maturing the strong performance of the Pakistani stock market would eventually put it on the radar of global fund managers to ultimately encourage flow of funds from abroad. In addition, Pakistani mutual funds industry is also looking ahead to get a boost from foreign funds in the West as and when they touch the saturation levels in term of returns to use Pakistani mutual funds market for higher returns.

Lack of public awareness has also been cited as one of the major detriments to the growth of the mutual funds. Though the beginning of mutual funds can be tracked back to as early as 19th century it was in 1924 that the first modern mutual fund; the Massachusetts Investors Trust, an open-end fund, was introduced in March 1924 in the America. But mutual funds only became popular after the Second World War and became mainstream investment in the developed world in the 1990s.

Mutual funds found their way into Pakistan in 1962 with the National Investment Trust, an open-end fund, and followed by the launching of Investment Corporation of Pakistan (ICP) in 1966 that ultimately managed 26 close-end mutual funds. Between 1962 and 1971 government enjoyed a complete monopoly in the mutual funds industry. In 1971, it allowed the private sector participation only in the close-end segment while the NIT kept on enjoying the monopoly until 1997 when the first private sector open-end fund- UTP- was launched. ICP has since been privatized while NIT still remains the only public sector mutual fund today, and the leader amongst all the mutual funds, and there are more private sector mutual funds, both open-and close-end, operating today than one can count.

Highly placed industry players blame both NIT and now-defunct ICP for their failure for failing in their duty to create the public awareness which is one of the major impediments for the growth of the mutual funds industry in the country. They say that though the ICP dominated the mutual funds market of the country managing 26 close-end funds for almost three decades it hardly did any marketing to help educate the people about the inherent benefits. On the other hand, they say that NIT kept on reeling from rip-offs from which the government had to bail it out at times.

While Pakistani mutual funds industry has been able to make inroads into a number of major markets in the region and beyond to explore the possibilities of technical, professional and business cooperation the fact remains that total investments in mutual funds still remains stagnating at around 5 per cent of the banking deposits depicting no change in the last three years. This is still worrisome despite the fact that total assets under management has increased from around Rs 90 billion to Rs 125 billion during the same period and also when compared to India total investments in mutual funds has increased from 15 per cent to 20 per cent of the banking deposits in the same period.

However, the silver lining in the sky is that the number of investors in mutual funds has increased to 160,000, according to the Chief Executive Officer UBL Fund Managers, Mir Muhammad Ali, at the press briefing organized to unveil the financial results for the half year ended December 31, 2006, which was attended by PAGE. Mr. Ali had also put the total investments in mutual funds in Pakistan at around 5 per cent of the banking deposits totaling Rs125 billion. Just about three years ago highly placed industry players quoted different figures about the number of investors that ranged from 'few thousand' to '75,000', according to Mr. Ali.

ABSENCE OF DISTRIBUTION NETWORK

Absence of distribution network is one of the other major reasons of the low penetration of mutual funds in the country. Villagers in India are investing in bonds, instruments and mutual funds because there exists a huge and efficient distribution network and where one can invest in mutual funds for as low as Rs 1,000 compared to minimum Rs 5,000 here. In addition, the huge rural distribution network in India is serviced by a highly specialized workforce to make mutual funds the preferred investment option at grassroots level.

The strength of the Indian mutual funds industry could also be attributed to its specialized workforce that interacts with the rural population constantly.

Though a number of banks have now diversified into mutual funds and are using their branch network as the springboard to tap the immense market that lays untapped still the mutual funds industry in general reels from the lack of distribution network. The Ministry of Finance has decided to convert the Central Directorate of National Savings (CDNS) into autonomous Pakistan Savings and has also decided to launch a mutual fund that would be managed by a professional assets management company as a subsidiary.

The formation of National Savings could act as a catalyst to enhance penetration of mutual funds to mobilize the resources. Around 320 branches of CDNS are presently marketing only government securities. The significant reduction in rate of return on fixed securities in recent years and with no access to securities that offer better returns, hundreds of thousands of small investors across the country are looking for option that the new mutual funds the National Savings would launch.

However, the biggest catalyst to take mutual funds to the rural areas could be the post offices that have a wide network across the country. These post offices that are performing their primary postal services could be used as the distribution centers of mutual funds. They are already issuing money orders and postal orders that make them an ideal place to market mutual funds.

The biggest advantage of using over 12,000 post offices nationwide that employ some 50,000 persons is that they are interacting with the people at grassroots level to an extent where a postman knows individuals by name.

IPOs

The government has announced to offer the IPOs of Pakistan Steel and the now privatized Habib Bank would also be listed on the national stock exchanges shortly. The listings would help the deepening and broadening of the stock markets as well as enhancing the investor base significantly as has been the case with the "privatization for people" policy pursued more actively by the former federal minister for privatization and investment, Dr. Hafeez Shaikh.

Mutual funds invest a substantial portion of their funds in IPOs which allows a large number of investors gain exposure to the stock market albeit indirectly. With the increase in free float, the market capitalization also offers tremendous investment opportunities that also impact the mutual funds industry positively because there are more stocks in the market to invest.

The perpetual lack of stability of the stock market in Pakistan could also be attributed to the absence of a strong mutual funds market. The development of mutual funds industry is thus essential for a stable stock market which in turn would have a trickle down effect on the overall economy of the country.

The overall positive response to the majority of IPOs, as has been the case particularly with the government offerings in the recent past, also positively influences the market sentiments. In addition, higher equity prices always have a positive impact on net asset values of mutual funds thereby allowing the investors in equity based mutual funds profit from rising equity prices.

Mutual funds have a future in Pakistan but the mutual funds industry should take it upon itself to create the much needed public awareness about the benefits of investing in affordable, comparatively low-risk investment in mutual funds that also offer comparatively higher returns.

It also has to convince the small investors that mutual funds is their best option for investment about the convenience to have indirect access to stock market, securities, money and equity markets, which otherwise is difficult to access on their own.

It is time for the mutual funds industry to reap the benefits of the liquidity and low interest rates that offer negative returns by convincing not only small investors but also medium and large investors, many of whom have lost fortunes in stock markets, that mutual funds offer the best investment option.

Educating the investors and accessing them wherever they are would help turn mutual funds a mainstream investment option in Pakistan like it has already become not only in the developed countries but also in neighbouring India.

Pakistan today has more mutual funds than ever before. The potential is tremendous. The increasing complexity of financial markets and sharp decline in interest rates has rendered the traditional modes of investment, such as National Savings scheme, unattractive for small investors. Converting CDNS into National Savings and allowing it to run a professionally managed mutual fund and turning of post offices into distribution centers is expected to enhance the base of mutual funds in the country.

Mutual funds need not remain the virgin investment territory anymore. The surface has already been scratched and it is time to make a deeper penetration of the immense potential that lays untapped but still that would only come with developing and nourishing a culture and the infrastructure that it needs.