NEED FOR CREATING AWARENESS

MUTUAL FUNDS GROWTH HAS BEEN SUBSTANTIAL BUT STILL CONSTITUTES A SMALL FRAGMENT OF FINANCIAL MARKET

SHABBIR H. KAZMI
Mar 17 - 23, 2008

Globally mutual funds are considered secure mode of investment for the small investors. The size of mutual funds in the developed countries is huge but countries like Pakistan are still in the process of learning.

High return on National Savings schemes and a number of crises of the equities markets have kept the small investors away from the mutual funds. However, the asset management companies are also partly responsible for the prevailing situation.

Asset management companies have not been able to cerate desired level of awareness among the masses about the benefits of investing in mutual funds. These companies suffer from limited outreach and also failing in developing alternative delivery channels.

It is evident that mutual funds though form a comparatively small segment of the securities market in Pakistan but the growth rate has been very attractive. The growth rate has been accelerated considerably with the increasing number of open-end funds.

Currently three forces are driving the global financial system 1) an increasing focus towards meeting client needs instead of product sales, 2) an increasing emphasis on the alignment of operations to manage and mitigate risk and 3) reliance on emerging, broad-based intra-industry utilities for trade processing, settlement, funds transfer etc.

According to Khalid Mirza, ex-chairman Securities & Exchange Commission of Pakistan based on these three drivers, the intellectual ferment in global financial circles is overwhelmingly about advisory services and client-specific or designer financial products, in line with what is called "client DNA". The talk is also about sales of risk and risk-reward packages as opposed to products, and about the importance of scale as well as the out-sourcing of back-end functionalities to seek cost savings.

Mutual funds are expected to continue to play an important role in the emerging global financial system. This is obvious from the industry's aggregate, world size of $ 21 trillion as against the world's financial assets that at present total around $ 120 trillion. The hallmark of the industry has been innovation, its ability to utilize and leverage off information technology, and the professional acumen displayed by its managers.

Pakistan was an early starter with the setting up of NIT in 1962 and subsequently the ICP mutual funds, for almost 40 years, until 2002, the progress made was not very impressive. The industry suffered both as a consequence of poor management as well as bad policies and the resulting distortions. In the recent past due to positive changes in government policy, improved regulatory framework, privatization and entry of new players the industry has witnessed growth in size as well as diversity of products.

The aggregate size of the local funds industry that was Rs. 25 billion in 2002 has now grown to Rs. 360 billion, equivalent to over $3 billion, which is spread over some 91 funds that are managed by 32 asset management companies. Rs. 315 billion assets are managed by open-end funds and the rest is with close-end funds.

According to some sector experts the total assets under management are, however, still less than 3% of GDP or 9% of bank deposits. As against this the size of Indian mutual fund industry is estimated around 12% of bank deposits, whereas in the United States mutual funds are about 155% of bank deposits. Also, it is noteworthy that the industry in Pakistan has come out with a fairly wide range of mutual fund products.

The mutual funds operating in the country deserve applauses for the excellent performance. However, one of the contentious issues is its smaller size compared to India and other countries of the region. In one of the articles placed on the website of Mutual Funds Association of Pakistan some of the challenges identified are its smaller size, its management is fragmented, its funding mostly comes from institutions and 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 key question going forward is what needs to be done to accelerate growth of mutual funds in the country. One point is clear that the sector has the potential to play the role of an effective and efficient channel for mobilizing much needed resources and allocating them to productive uses. There are and there will always be constraints and issues needing immediate attention of the regulators.

National Savings Schemes have been offering the toughest competition to the mutual funds. However, with the slashing of rates of return on these schemes it was expected that small investors would start looking at mutual funds as one of the options but the target has not been achieved. Similarly with banking spreads hovering around 7.5% mutual fund managers have a lot of room to improve their earnings.

Nonetheless, it is sincerely believed that policy makers and regulators in Pakistan will take the responsibility to adopt a progressive and enlightened view of mutual funds and will take such measures which are necessary to enhance the effectiveness of the industry as an important pillar of the financial system.

Some of the suggested measures to facilitate growth of mutual funds are:

First, the government should use commercial ways of meeting its budgetary deficit. National Savings Schemes may offer good returns to "the less privileged" but investment by the institutions in these schemes has to be stopped completely. And the government will have to stop offering high return to mop up funds.

Second, policy makers should adopt cogent measures to promote the provision of pension and retirement benefits to the substantial part of the population. However, it would not be feasible without the involvement of competent fund managers.

Third, regulators will have to play a proactive role for encouraging innovation and new product development.

Fourth, it is important to address the issue of governance of mutual funds to reduce the deep discount to NAV suffered by closed-end mutual funds. Some form of accountability of fund managers to the fund certificate holders should be introduced through structures such as the convening of annual meetings of certificate holders, establishing advisory boards, or through other suitable ways.

Fifth, the code of conduct for mutual fund managers may need to be strengthened in line with international best practice. In particular, compliance procedures need to be strengthened.

Sixth, regulators will have to take visible steps to ensure that mutual fund managers conduct their activities with integrity, act 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 they can achieve.