Mar 02 - 08, 2009

Mutual funds are the vehicles providing a pool for savings of various investors individuals as well as institutions, collectively placing such savings in stocks, bonds, and/or money market instruments. These institutions offer a diversified investment portfolio that helps to reduce exposure risks for individual investors and allows sharing of transaction costs among all investors.

Comparatively, stock funds are considered more risky than bond funds or money market funds. Along with greater risks comes the potential for greater returns. Over a long period, equities have historically outperformed both bonds and cash investments, and when stocks do well, stock mutual funds naturally follow suit. These funds are sub divided based on their objectives, management styles, and type of holdings.

Mutual funds are not new entity in Pakistan, in fact the industry dates back to 1960s, when only National Investment Trust (NIT) and Investment Corporation of Pakistan were operating. Now a thriving segment of financial sector, mutual funds has shown an astonishing growth in both numbers and volumes. Investor choices have been expanded to 95 funds with total net asset value of PKR. 330 billion compared to PKR. 24.8 billion in FY02, a multiplier of 13. These funds are managed by 39 licensed asset management companies.

Mutual funds paid out an average profit of 22.1% in FY07 and 18.0% in FY08. The growth in mutual funds in Pakistan is attributable to:

Liberalization of this sector
Economic growth and macro economic stability
Increased liquidity with institutional investors
High corporate earnings
Buoyant stock market

This extraordinary growth was not observed during the current year, as the credit crunch changed the financial landscape of the world and these tremors harshly affected the emerging markets. The KSE 100 index fell from about 16,000 points to approximately 5,500 points. The decline was caused by liquidation of foreign holdings and flight of capital.

This is nothing new, but a rather regular feature associated with foreign direct investment (FDI) and we have witnessed the same in Malaysia, Hong Kong and Singapore stock exchanges a few years ago. Domestic investments paved the comeback trail of these stock exchanges and stabilized their performance in terms of growth and yield.

The Pakistani mutual funds did not suffer the direct impact of these crises, as they had no holdings in the international markets. However, due to a decline in the KSE 100 Index and locked floor for 3 months, it faced stagnation. Just as every cloud has an unseen benefit, the current situation makes stock funds more affordable investment vehicle.

What makes this segment lucrative? The answer lies on the other side of these crises. The deep value available today offers an attractive opportunity as these investments are discounted in the years to come.

This claim is grounded in the fact that many of the underlying companies are still expecting solid business growth, diversified revenue streams, and a clear path to higher earnings. The rational thing to do at the moment is to invest in companies with better debt ratio, good and sustainable revenue streams and a history of solid dividend growth that pays out higher for the risk taken.

According to Mr. Javed Hassan, Executive Director, IGI Funds, "The expertise of the funds manager in identifying and selecting investment options is the most important incentive for investing in mutual funds". Risk management is vital to the health of any fund, efficiency in yielding profits and undermining risks is core operation of the mutual funds.

Another advantage of investing in stock funds is that investors can redeem their funds anytime they want to, at the prevailing redemption price of the fund, which is quoted on a daily basis, taking out the element of premature penalty embedded in fixed income funds.

Experts who use sophisticated market analysis tools in order to take advantage of market movements as they arise professionally manage mutual funds.

Although all stock funds are similar, they differ in asset allocation plus stock selection, distinguishing one stock fund from the other.

The major sub segments of stock funds are:

Growth Funds - focusing on long term capital gains by capitalizing on companies experiencing significant earnings or revenue and paying very low dividend

Value Funds - invest in companies that have matured and have low P/E ratio but channel their earnings into dividends thus providing current income and associated long term growth

Aggressive Growth Funds - invest in companies which experience rapid earnings and revenue growth

These funds have a very high yield coupled with volatility as these funds trade frequently and take more risks than regular growth funds.

Blend Funds - investments in both value and growth stocks ensure a blend, which provides current income and long term capital appreciation

These funds are relatively less risky than growth funds and riskier than value funds.

Sector Funds - focusing on a single sector of the market, such as energy, chemicals, etc.

Such funds are growth oriented and eye sectors that are performing or expected to perform better in future.

Focused Funds - holding large positions in small number of stocks, emphasizing quality over quantity

Instead of diversifying across a large number of holdings, investments are made in stocks, which are a safe bet. Although they are focused, these funds are scraped of diversification and tend to be more volatile than other mutual funds.

For starters, one should set his investment objectives and try to match them with the available stock funds sub categories. The second step is to evaluate the pros and cons associated with the choices. A thorough understanding and information about the holdings and past performance of the fund and market trends should prove to be sufficient in controlling volatility and coping with involved risks while attaining a substantial return on investment.