EVOLUTION OF MUTUAL FUNDS IN PAKISTAN

SUMAIRA FAZAL
Feb 09 - 15, 2009

A mutual fund is a tool for pooling together savings of diverse investors - both individuals as well as institutions - to collectively invest these savings in stocks, bonds, and money market instruments. It offers several advantages, particularly to retail investors, over taking direct exposure in capital and money markets.

Besides professional management, mutual funds offer a diversified investment portfolio that helps to reduce exposure risks for individual investors and allows sharing of transaction costs among all investors. The first ever officially regulated mutual fund was launched in USA in 1924 and over the period the sector has grown manifolds.

The evolving scenario of the global financial system that stems from client-advisory services, evolving risk management concepts, commoditization has actually flourished the industry.

In many developing countries, including several middle-income economies, mutual fund industry has displayed considerable progress in recent years. Pakistan has an early start with setting-up of NIT in 1962 - an open-ended mutual fund established in the public sector. Establishing this fund, Pakistan became the first country to have mutual fund in South Asia Region.

Thereafter, Investment Corporation of Pakistan (ICP) was established in 1966 that too in the public sector to float and manage closed-end mutual funds. It launched 26 funds in total. Since the initial start-up, the progress in the sector had been very slow till almost 2002. That had been a consequence of poor management and lack of innovations, and lack of support at regulators and policy makers' end. However, during around past five years, considerable improvement was witnessed, thanks to economic growth and positive policy and regulatory measures taken in favor of the mutual fund industry.

The securities and exchange commission of Pakistan (SECP) is the principal regulator and has played an active role in recent years in creating an enabling regulatory environment for the sector. The commission revised regulations for non-banking financial institutions (NBFCs) in 2007 - keeping in view the changing market dynamics and to bring the industry inline with the international best practices.

To better equip the companies operating in the mutual fund sector for meeting the upcoming challenges, and enhance their financial profile and operating capabilities, the minimum equity requirements for all forms of businesses, including investment advisory and asset management business have been raised. This is to be met by the existing players in the phased manner by 2010. Also, under the revised rules, NBFCs seeking to undertake asset management and investment advisory services are barred from directly conducting any other form of business. The other major revision pertaining to the asset management industry includes permission to provide private portfolio management services, which was permissible only to investment finance companies previously.

The aggregate size of the total industry that was only PKR 25bln in 2002, augmented to around PKR 350bln at present. There has also been increasing trend of new funds being floated. Meanwhile, a number of new asset managers have entered the sector, taking the total number of asset managers to more than 30. The growth in the mutual fund industry had been attributable to (i) liberalization of the sector, (ii) economic growth and macroeconomic stability that attracted investors, (iii) increased liquidity with institutional investors, which was channelized into the stock market and mutual funds, (iv) high corporate earnings that increased the earnings potential for mutual funds and buoyant stock market that provided mutual funds with good returns in the form of capital gains previously.

Liberalization helped to facilitate entry of the private sector in the mutual funds industry. Historically, the industry was dominated by public sector funds. However, creation of an enabling legal framework to allow mutual funds to be set up in the private sector and transfer of ICP-managed closed end funds to two private sector investment advisors in 2003 boosted the number and size of funds under the management of the private sector, increased competition and efficiency of the sector enhanced the quality of the fund management. It also provided opportunity to the financial institutions like banks and brokerage firms to diversify into fund management through subsidiaries and associated companies.

However, despite healthy transformation in the recent past, the industry is still at an initial stage of development and is far behind the other countries in the region, in terms of relative size, investor base and depth in structure. Since equity funds dominated the industry, growth in Net Asset Value (NAV), in turn growth and performance of funds - is directly attributable to the performance of stock markets in recent years. Therefore, the melting-down of the stock market in 2008, particularly the later part of it, created a mess for mutual funds industry.

The bottom line of the industry got a dent owing mainly to the losses on equity investments thus the net income of the total industry remained lower than half as compared to last year (FY07: 47.5bln, FY08: 22.2bln). The range-bound scenario of the bourses is likely to continue, thus impacting the overall performance of the mutual fund industry negatively. Given this scenario, there is a strong need of support on legislative front. Also, considering the fact that the growth of the industry is linked with the overall economic position, the recent downturn, both on domestic macro-economic and global fronts, could pose more challenges to the sector.