MUTUAL FUND

DAWOOD CAPITAL MANAGEMENT RESEARCH TEAM,
Research Analyst
, PAGE
Dec 7 - 13, 2009

A mutual fund is a collective investment scheme, which specializes in investing a pool of money collected from many investors in to securities such as stocks, bonds, money market instruments, and similar assets.

There are two types of mutual funds by structure, open end, and close end. In Pakistan mutual fund is constituted as a trust. It has a Trustee, Sponsor, Asset Management Company (AMC), Registrar and Custodian.

Sponsors establish fund. Trustee holds the property of the fund in its custody for the benefit of the investors and hence acts as a custodian as well. Registrar keeps the data of all the investors either electronically or on paper. Securities and Exchange Commission of Pakistan (SECP) approves AMC and all investment is done in a fund under its guidelines.

Mutual funds have a vital role in the economy of a country. Globally it is considered as a booster to the formation of the capital market of any country.

The history of mutual fund began in 1924 when three Boston securities executives created the very first mutual fund by pooling their money together to form Massachusetts Investor Trust.

Today in the USA, there are over 10,000 mutual funds available. These mutual funds have size of 7 trillion dollars and 83 million investors.

Almost every individual in US invests in the mutual funds to utilize his/her idle money to generate healthy returns according to his/her risk appetite.

Almost every commercial bank in the western countries provide their account holders an opportunity to invest in the mutual funds through their accounts in the form of IRAs (Individual Retirement Accounts). In fact, every commercial bank owns some kind of mutual fund to cater the needs of their clients.

Mutual funds have a very important role in the economy of Pakistan as well. In Pakistan mutual fund started in 1962 with the establishment of National Investment Trust (NIT). But, actual mutual funds gained its popularity after 2003 and now we have about 30 plus AMCs offering about 150 plus different kinds of mutual funds plans according to needs of investors.

Mutual funds are one of the major sources of employment as thousands of people are engaged with this industry. In Pakistan, all AMCs jointly created a body, MUFAP (Mutual Funds Association of Pakistan) in order to safeguard their interests and to ensure a healthy market for their smooth operations.

Mutual fund not only provide a good investment alternative to the investors at grass root levels but also fuels the economy by providing necessary capital from surplus agents to deficit agents. They are also one of the major sources of employment as well. The major advantages of mutual funds are:

1. Diversification
2. Reduced transaction cost
3. Tax free returns
4. Professional management

CATEGORIES OF FUNDS

Mutual funds are generally categorized broadly in money market fund, equity (stock) fund, bond fund, and hybrid (balanced) fund

Money market fund invests in short-term high quality investments issued by the government, corporations, and state and local governments. Money market funds appeal to the investors because of no sales and redemption charges, average maturity ranges from 1-3 months, thus providing liquidity, any time redeemable (being and open end), interest earned which is ongoing in the market, diversification and professional management, and safety of capital.

Equity (stock) fund invests in the stocks of the companies. They are highly risky and volatile as their value rise and fall very quickly depending on the performance of the stock market. Equity funds are generally divided into two categories based on their approach to selecting stocks.

Value fund generally seeks to find stocks that are cheap because of standard fundamental analysis yardsticks such as earnings, book value, and dividend yield. They focus on dividends on the stocks.

Growth funds, on the other hand, seek to find companies that are expected to show rapid future growth in earnings, even if current earnings are poor or possibly non-existent. They focus on large capital gain rather than dividend.

Bond fund invests in bonds issued by both government and private corporations. They are riskier than money market funds because they aim to earn higher returns.

Hybrid (balanced) fund invests in the combination of stock and bonds thus providing the combined features of both bond and stock funds.

Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.

PERFORMANCE OF MUTUAL FUNDS JULY-SEP FY10

The performance of mutual fund was outstanding during the first quarter as total mutual fund industry increased 14.79 % to reach Rs235.2 billion as compared to Rs204.9 billion as of June 30, 2009, an increase of Rs30.3 billion in absolute numbers.

PERFORMANCE TABLE

CATEGORY JUNE 30, 2009 SEP 30, 2009 % CHANGE
Income & Money Market Fund 81.79 91.79 12.20
Equity Funds 63.10 74.49 18.06
Hybrid Funds 6.77 6.14 -9.3
Islamic Equity Funds 4.50 5.67 26
Islamic Income Funds 7.85 8.85 12.70
Balanced Funds 6.54 7.10 8.52
Asset Allocation Fund 2.34 2.46 5.13
Islamic Asset Allocation Fund 2.88 3.09 7.46
Fund of Funds 0.71 1.01 41.70

Open-end fund increased by Rs24.12 billion in 1QFY10 and Closed Funds increased by Rs6.27 billion. Total industry size reached at Rs235.2 billion against Rs204.90 billion as of June 30, 2009.

RECOMMENDATIONS

Current financial crisis has shaken the investors' confidence in the capital market, which adversely affected the mutual funds industry in Pakistan. Now there is a dire need from the regulator and association to come forward along with AMCs to play their due role in the development of this industry.

The steps taken by players of the industry seem inadequate to restore the investors' confidence. In fact, such measures (including freeze of stock market and equity funds) engendered confusion.

This industry had a very successful period during 2006 and 2007. At that, AMCs were managing all time high assets under management. But now, the situation has changed.

The assets under management have cut by half. It is true that the values are bottomed out but at the same time, the probability of a rebound is also reasonably high.

All stakeholders should take certain steps to educate the investors especially retail and households and promote awareness about their investment products through advertisements, media, training programs etc. as it is observed that funds focusing on retail clientele can become stronger. They should strive hard to provide more conducive environment to the investors.

The size of the mutual funds in Pakistan is still very small as compared to developed counties and even India. The sector cannot be strengthened without broadening retail investor base. This objective is hard to achieve without attracting small investors, extending outreach, and ensuring uninterrupted redemption and sales.

Misrepresentation by sales agents is also a major reason for the setback. They should provide realistic information to investors regarding the risk profile of the mutual funds so that the Code of Ethics for Investments is not violated.

AMCs have to invest in long-term illiquid investments as there are lacks of investment avenues at present. Regulator and association with collaboration with investment companies should provide enough investment avenues in the market to cater to the increasing needs of the investors. At the same time, AMCs should concentrate on their strategies to bring more and more retail investors to the industry.

The need is to develop a confidence of households and also institutions in these investments products. Investing small savings of households in a huge pool of investment baskets, with the support of institutional investments, can enable our economy post success story of mutual fund similar to west.