The savings to GDP ratio is already low in Pakistan. With the reduction in purchasing power and declining rates of return on bank deposits and national savings schemes, analysts fear further decline in savings rate. Therefore, it is of prime importance for the people to know about the various available investment options to maximize return on their savings. At present equities offer very attractive dividend yields. However, an average person neither has the expertise nor the required information to take the best advantage of the available opportunities.
While building a high yielding portfolio is very difficult, one can maximize his or her return by investing in mutual funds. Theoretically, a mutual fund is a pool of money belonging to a group of investors entrusted to a Fund Manager hired by the group. The Fund Manager invests the money on behalf of the investors. The Fund Manager is paid a management fee. If there is a profit or gain on investments, it belongs to the investors. In case there is a loss, it is also borne by the investors.
Traditionally, there are two types of mutual funds: 1) closed-end fund and 2) open-end fund. A closed-end fund has a fixed pool of money, which is collected when the fund is set up. The fund is set up as an investment company with a certain amount of capital. The Fund Manager invests the money in capital markets. An investor wishing to participate in this type of mutual fund buys shares of the investment company at the time of its initial public offer. An investor may also buy shares subsequently from the stock market at the prevailing market price. If the investor wishes to disinvest he/she has to sell the shares of investment company through stock exchange at the then prevailing price. The price of the shares of investment company in the stock market is determined by the supply and demand for such shares.
An open-end fund does not have a fixed pool of money. The fund manager continuously allows investors to join or leave the fund. The fund is set up as a trust, with an independent trustee, who has custody over the assets of the trust. Each share of the trust is called a unit and the fund itself is called a unit trust. The portfolio of investments of the unit trust is evaluated (normally) daily by the fund manager on the basis of prevailing market prices of the securities in the portfolio and the net asset value (NAV) per unit is determined. An investor can join or leave the fund on the basis of the NAV of the unit. However, the fund manager may have a small charge called 'load' added to the selling price or deducted from the redemption price to cover distribution costs.
Mutual funds enjoy strength because of availability of professionals, ability to diversify, expertise to match investment with risk and large liquidity. An average investor is not well versed with the market, may not have access to adequate information or does not have time to acquire information and analyse it. By investing through a mutual fund, the investor is able to acquire the services of a team of professionals dedicated to the investment business at a very low cost. An investor normally invests small amount and cannot achieve an adequate level of diversification. An investor who wish to invest small amount can do so by investing in mutual funds. Whereas such small investors are not entertained normally by the brokers.
Mutual funds invest in a variety of products, i.e. equities, debt instruments and money market instruments. Such a diversification on the one hand minimizes the probability of losses and on the other hand allows the investors to chose a fund of its own choice. At the same time allocating one's fund to several mutual funds, the investor can balance out the investments into a combination that suits his/her risk taking ability and preference for the intervals of receipts of returns.
Money invested in mutual funds can be redeemed either by selling the shares of a closed-end fund in the market or simply asking the fund manager for redemption in the case of an open-end fund. There are no penalties for early termination of an investment, which one may have to suffer in the case of term deposits with banks or other savings schemes.
Key Players
At present a number of closed-end as well as open-end mutual funds are operating in Pakistan. Among the oldest are NIT and the various funds managed by Investment Corporation of Pakistan (ICP). The largest number of listed mutual funds, twenty six, are managed by the ICP. There are 11 closed-end mutual funds operating in private sector. Whereas NIT and ICP operates in public sector. The GoP intends to privatize both the entities. The total paid-up capital of 37 mutual funds listed at Karachi Stock Exchange is over Rs 4,751 million. However, a number of these are being quoted below face value.
According to some sector analysts the number of mutual funds, their paid-up capital and number of investors in mutual funds is too small. They attribute this to a number of factors, worst being the GoP policies. 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 keep the population of India and Pakistan in mind, the ratio is still dismal.
They say that one of the major reasons for growth of mutual funds has been the GoP insistence on not allowing establishment of open-end funds in the private sector. At present only one such fund is operating in private sector in Pakistan, BSJS Balanced Fund. The apprehensions of the regulators were that private sector could not manage an open-end fund efficiently and prudently. This impression was mainly due to the poor performance of closed-end funds managed by the private sector.
Most of the private sector closed-end funds were established in early nineties, when there was a boom in equities market, prices of scrips were high and investment in equities only was possible — corporate debt and money market instruments were not common at that time. Therefore, when equities market plunged most of the funds posted huge losses. Some analysts say, "While a lot of blame goes to sponsors and managers of private sector funds, the market conditions were also responsible for the fiasco."
However, some analysts say, "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. If one may recall, a number of mutual funds were sponsored by brokerage house 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 announcement of results by Arif Habib Securities, BSJS Balanced Fund and NIT indicate that all those funds which are managed prudently and efficiently have the potential to earn substantial profit. The year ending on June 30, 2002 was a difficult year but these funds managed to earn good profit. Some of the ICP managed funds have been posting good performance but are being traded below the NAV.
NIT has announced 12 per cent dividend for the year 2002. NIT was established in 1962 and has over 60 per cent share of market share of mutual funds sector. At present it has over 60,000 unit holders who collectively hold 1.6 billion NIT units. The total value of funds invested in the market by NIT is estimated around Rs 19.5 billion, at current market prices. This is approximately 5 per cent of the total market capitalization at Karachi Stock Exchange, making NIT the single largest investor at the exchange.
BSJS Balanced Fund has posted over Rs 56 million profit and announced 15 per cent dividend for the year 2002. During the year it also acquired Security Stock Fund. As a result of merger the paid-up capital of fund increased to Rs 340 million. To increase the capital, the fund intends to issue Redeemable Preference shares subject to the approval from the SECP. The fund is called a balance fund because of its investment in equities, debt instruments, money market and COT.
Arif Habib Securities, the main sponsors of Arif Habib Investment (AHI), has posted Rs 253.6 million profit for the year 2002 and announced 50 per cent dividend as well 20 per cent bonus shares. AHI manages Pakistan Stock Market Fund and Pakistan Income Fund.
Outlook
While most of the equities market 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 investors confidence in equities market is the SECP's drive to improve level of corporate governance at the listed companies.
Analysts also suggest that the GoP must allow establishment of more and more open-end funds to ensure greater liquidity for the capital market. The flotation of large number of TFCs is a clear manifestation that more and more corporates now prefer to mobilize funds through debt instruments rather than borrowing from financial institutions.