ASSESSING MUTUAL FUND INDUSTRY

AROOJ ASGHAR (arooj.asghar@hotmail.com)
Mar 17 - 23, 2008

After 2002, mutual fund industry in Pakistan has witnessed significant changes and growth in terms of private sector participation and divestment of public sector funds. This faction in Pakistan is still in its growing phase. Overall results of the capital markets as well as funds suggest that mutual funds in Pakistan are able to add more value. Worldwide there had been a tremendous growth in this industry; mainly because of the overall growth in both the size and maturity of many foreign capital markets, we are far behind. By 2002, there were only two companies; the National Investment Trust (NIT), the biggest and the oldest, which represented the public sector; and the second and the only one operating in the private sector was ABAMCO, which was managing only one fund. In 2002, private sector joined in and now the total number of asset management companies is around 34. The total investment in bank deposits including national saving schemes - two areas where common people invest - is around four trillion rupees, and the total investment in mutual funds is hardly 200 million rupees, around five percent of the total savings in banks and NSS. If compare with a developed mutual fund market such as the United States, it seems obvious that the investment in the mutual fund industry is around 1.2 or 1.4 times higher compared to bank deposits, which shows the potential of growth in an underdeveloped market like ours. With developments in the previous few years, we are heading in the right direction.

Currently mutual funds account for only 2.4 percent of the country's GDP as compared to 6.0 percent for India and 69.0 percent for the USA. Mutual fund accounts for 16.5 percent of Pakistan's national savings. This sector holds great potential for future. The industry has witnessed phenomenal growth during the last 4-5 years. Its total assets have increased from Rs 25 billion in June 2002 to about Rs 215 billion in March 2007, showing an increase of 760 percent. The industry has gained popularity due to its improved and disciplined behavior, government support, development of specialized innovative products and investment friendly environment. In March 2007, there were 67 mutual funds as against 46 in June 2006, which included 43 open ended and 24 close ended funds. Besides, 19 more were in the pipeline. At present there are 34 assets management companies registered and licensed by the SECP. New and innovative products are being designed and offered in the market for both corporate and individual investors.

As far as the composition of funds in Pakistan market is concerned, a break up reveals that out of total, 49% are equity funds, 23% are balanced funds whereas 29% are Islamic funds. During first quarter of FY 2008 the best performer on average was Islamic Fund Category that with a return of 2.45%. The local open-end equity mutual funds constitute about 0.29% of the total market capitalization of Karachi Stock Exchange in September 2007. The recorded size of the open-ended equity funds came to about PKR128 bn including NIT. NIT being the oldest and the largest constitutes about 78.12% of the open-ended equity funds. However the total equity fund industry excluding NIT is worth PKR 27.8 bn. NIT in Pakistan and UTP in India were established around the same time. While the value of portfolio of UTP India exceeds US$ 44 million; the portfolio of NIT is too small compared to that of its Indian counter part. The same is also true about the number of unit holders. Even if one keeps the population of India and Pakistan in mind, the ratio is still dismal.

The current scenario of capital markets have exhibited a volatile spell and in 2007 the KSE-100 Index plunged to the lowest level of decline of 17.3%, which was triggered by domestic political instability as well as a net outflow of foreign investment due to credit concerns in the US sub prime mortgage market. This sub prime issue affected markets all around the world and an average decline of 10% - 15% was observed globally. In line with the capital markets the local mutual fund industry showed an average decline in returns of only 0.56% as compared to an overall 4.15% decline in KSE-100 index in first quarter of FY08. However now the mutual fund industry has taken intelligent investment decisions and has regained momentum as monthly returns are likely to demonstrate significant increases over the market.

It largely depends on maturity of the market and the choice of investor to invest in banks or mutual funds. As banks are not passing on the benefits as much as they can, therefore more and more investors are deviating towards mutual funds market. The growth in this sector shows that investors have started to realize that there are many types of funds and investment modes such as money market fund, debt funds etc, which are almost as low-risk as deposits in banks or NSS, with far better potential for returns. The new products so far offered include shariah complaint products, sector-specific products etc. The new products to be offered in the near future include pension funds, real estate funds, infrastructure funds etc., which are being developed to suit investor's risk and return profile and their cash flow needs. The mutual funds industry has attracted attention of professionals, entrepreneurs and investors alike. This enabling environment has led to phenomenal increase in the number of mutual funds. The industry is on the path of steady progress and competing with banks in attracting savings, besides supporting and underpinning the stock market activities. The mutual funds sector is set to attract growing pubic attention owing to better investment prospects and effective role in brining about betterment in the national economy. The sector is now focusing on specialized financial products aimed at niche markets with a view to cater to the requirement of all types of investors. The performance of the mutual funds industry has generally kept pace with the performance of the stock market. The permission granted by the SBP to local mutual funds to invest 30 percent of their assets abroad with a cap of US $ 15 million has enhanced the image of mutual funds among the investors. During 2006 before taxation profit of 23 close ended mutual fund was Rs 8.28 billion as compared to Rs 7.55 billion during 2005. Although asset managers are working on innovative financial products, there is a real need to create general awareness about mutual funds in the retail segment of investors. Mutual funds are set to give tough competition to NSS and Bank Deposits in the near future, provided the asset managers and the financial planners work collectively in establishing enlightenment among the masses, the market, which is still largely untapped.

UNDERDEVELOPED MARKET - CAUSES

In Pakistan most of the private sector closed-ended funds were established in early nineties, when there was a boom in equities market, prices of scrips were high and only possibility for investment was in equities - corporate debt and money market instruments were not common at that time. Therefore, when equity market plunged most of the funds posted huge losses.

Another major reason for impediments in growth of mutual funds has been the GoP insistence on not allowing establishment of open-ended funds in the private sector. The apprehensions of the regulators were that private sector could not manage an open-ended fund efficiently and prudently. This impression was mainly due to the poor performance of closed-ended funds managed by the private sector.

It is true that market sentiments led to huge losses, but the blame should also go to sponsors for managing funds in imprudent manner. Some of the funds were used for 'parking' of bad transactions. A number of mutual funds were sponsored by brokerage houses or those who used the funds for trading of equities. Most of these sponsors indulged in speculative trading rather than taking long positions or making long-term investment. The concept of parking of bad transaction in mutual fund account was used to avoid immediate loss, in the hope of recovery. The recent results by various asset management companies indicate that all those funds which are managed prudently and efficiently have the potential to earn substantial profit.

FUTURE OUTLOOK

While most of the equity markets around the globe have plunged due to erosion in the faith of investors in 'Corporate America', the KSE-100 index has shown range-bound movement. This can be attributed to two factors, strong economic fundamentals and incredibly attractive dividend yield. Corporate earnings are expected to remain high. Since most of the mutual funds have large exposure in equities. Any improvement in corporate earnings is expected to have positive impact on them. Another factor which has the potential to boost investor's confidence in equities market is the SECP's drive to improve level of corporate governance at the listed companies. The regulators along with the institutions need to promote international best practices and corporate governance, spread consumer awareness and maintain investor's confidence.

Analysts also suggest that the GoP must allow establishment of more and more open-ended funds to ensure greater liquidity for the capital market. The flotation of large number of TFCs is a clear manifestation that more and more corporations now prefer to mobilize funds through debt instruments rather than borrowing from financial institutions.

Government should take prompt and closely controlled steps to enhance the mutual funds industry in order that it clearly plays its role of underpinning the financial markets and serves as an effective channel for mobilizing resources and allocating them to productive uses. In reference to bank reserve requirements, permissible provident fund investments etc, policy makers should not distinguish between government securities and mutual funds accredited with high, investment grade, ratings. As far as possible, there ought to be a level playing field between investing in mutual funds and in Government securities. Policy makers should adopt cogent measures to promote the provision of pension and retirement benefits to a substantial part of the population and clearly this would not be feasible without the involvement of competent fund managers.

A good fund manager is required to follow the policy or strategy that he has defined or committed to the investors regarding the fund they are investing in. If a fund was introduced as a money market fund, then the fund manager should keep his commitment and not enter any other market, such as the share market, which has different levels of risk and requirements. And if the fund was structured to cater short-term investment, then it should really work as a short-term investment strategy. Similarly if fund is for speculative trading, it should act like a speculator, but on the other hand, if commitment with the investors was for a growth fund, manger has to restrain from acting otherwise.

The funds should also disclose the level of risk associated with return in their annual reports for the information of investors and prospective investors. This will enable the investors to compare the level of return with the level of risk. The success of this sector depends on the performance of funds industry and the role of regulatory bodies. Excellent performance and stringent regulations will definitely increase the popularity of mutual funds in Pakistan.