MUTUAL FUNDS AND ECONOMY

MUTUAL FUNDS AND ECONOMY WITH REFERENCE TO PAK ISTAN

BA S I C R E S E A R CH

INSTRUCTOR

DR. ABUZAR WAJIDI CHAIRMAN EVENING PROGRAM

DEAN FACULTY OF MANAGEMENT SCIENCES

PREPARED BY:

MUSTANSIR SHABBAR SEAT NO. 072264

MPA PREVIOUS FINAL (FINANCE) JANUARY – MAY 2009

DEPARTMENT OF PUBLIC ADMINISTRATION

UNIVERSITY OF KARACHI

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TABLE OF CONTENTS

ACKNOWLEDGEMENT………………………………………………………2

CHAPTER I BACKGROUND OF STUDY…………………………3 INTRODUCTION ............................................................................................ 4

OBJECTIVE .................................................................................................. 5

SIGNIFICANCE OF THE STUDY ..................................................................... 5

SCOPE AND LIMITATIONS ............................................................................ 5

DELIMITATIONS ............................................................................................ 6

CHAPTER II LITERATURE REVIEW……………………..7

CHAPTER III SUMMARY…………………………………44 CONCLUSION ............................................................................................. 45

RECOMMENDATIONS ................................................................................. 46

BIBLIOGRAPHY……………………………………………….48

APPENDICES…………………………………………………………………50

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ACKNOWLEDGEMENT I thank to the Almighty Allah for giving me strength, courage, patience and inspiration to complete this Research Report. I am also very sincerely grateful for the efforts of those who in one way or other have contributed to the successful completion of this piece of work. I am especially thankful to my course coordinator Dr. Abuzar Wajidi for his guidance, help, advice and encouragement that led to the successful completion of this project. I am also very much thankful to my company executives and colleagues for their precious time given to me for discussion and research materials provided to me. Last but not least, I must appreciate the efforts of all respondents including employees of MUFAP, Asset Management Companies, Research Firms and Investment Facilitators who have supported me in my research.

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CHAPTER I

BACKGROUND OF STUDY

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INTRODUCTION A mutual fund is a collective investment scheme, which specializes in investing a pool of money collected from many investors for the purpose of investing in 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. Fund is established by Sponsors. 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. AMC is approved by Securities and Exchange Commission of Pakistan (SECP) being a regulator and all investment will be done in a fund according to the guidelines provided by the SECP. Mutual funds have a vital role in the economy of the county. Globally it is considered as a great booster in the formation of the capital market of any country. The history of mutual fund probably began in 1924 when the very first mutual fund was created by three Boston securities executives when they pooled their money together to form Massachusetts Investor Trust. Today in the US there are over 10,000 mutual funds available. These mutual funds are collectively worth more than 7 trillion dollars divided by 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 to invest in the mutual funds through their accounts in the form of IRAs (Individual Retirement Accounts), in fact, every commercial bank owns a some kind of mutual fund to cater the needs their clients. It shows how much popular and useful tool mutual funds are for the economy of the western countries. 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) and public offering of NIT which is an open end fund. But actual mutual funds gained its popularity after 2003 and now we have about 30 AMCs offering about 120 different kinds of mutual funds depending upon the investors needs. Mutual funds are our one of the major sources of employment as thousands of people are engaged with this industry. In Pakistan all AMCs have jointly created a body, MUFAP (Mutual Funds

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Association of Pakistan) in order to safeguard the interest of the AMCs and to ensure a healthy market for their smooth operations. It does 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

Globally mutual fund refers to the open end investment schemes. Although in Pakistan it refers to both open end and closed end. But for better understanding and simplicity we will confine this research to open end mutual funds which have a more prominent role in the economic development and more preferred investment choice of investors throughout the world.

OBJECTIVE The goal of this study to enhance the knowledge about the importance of mutual funds and their role in the capital formation of any country especially Pakistan by giving comparisons with western countries especially USA.

SIGNIFICANCE OF THE STUDY This study will provide useful information about the mutual funds as an excellent investment tool which is not only used in our economy but globally it serves as a common way to generate returns to beat the inflation rate.

SCOPE AND LIMITATIONS This scope of this research is based on the data available in the market through the publications of the reports by Asset Management Companies on monthly, quarterly and yearly basis and by the data released by the Mutual Funds Association of Pakistan (MUFAP) on timely basis. For western countries comparisons, the data is based on the reports released by the

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Investment Company Institute (a research firm in USA) on its website (www.ici.org). I have mostly included the data as at June 30, 2008. It is also based on the views and perceptions of the investors and independent people in the market.

DELIMITATIONS Changes might occur during course of study. Things as planned might not turn out to be the same. The delimitations involved in my research are as follows:

• Changes in the investment climate • Changes in the performance and working of money market and capital

market • Changes in investors perception • Change in the regulations that govern the financial markets

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CHAPTER II

LITERATURE REVIEW

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This review is divided into two parts for the ease of readers. Firstly, Global Review of Mutual Funds which is mainly of United States of America because more than half of the total assets under management of mutual funds are in USA; and then, secondly, Mutual Funds in Pakistan. The success story of any economy can only scripted on the basis of sound financial system. During the last century mutual funds emerged as an indispensable tool for stabilizing the economy; and mobilizing and channelizing the savings of millions of individuals and institutions. Today mutual funds are playing significant role in providing financial services in the financial industry throughout the World. The successful economies of developed western countries including USA and other European countries have trillions of dollars invested in mutual funds. Approximately every individual in US invests in mutual funds. Also our neighbor India has more than 800 billion of dollars invested in mutual funds which is considered as the largest market of Asia and there is a prediction that it will cross $1 trillion up to 20151. Investors can invest directly by buying and selling securities by themselves, typically through their own brokerage accounts. They have direct control over them. They have wide varieties of securities available to choose. But investing directly requires extensive knowledge of financial markets which a common person does not have. For them, indirect investing is the best option. It involves leaving the investment decisions to others, technically to professional experts. Mutual funds are the best available option for indirect investing, which offers professional fund managers to manage the portfolio of securities on behalf of investors. A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share represents an investor's proportionate ownership of the fund's holdings and the income those holdings generate2. Purchasing a mutual fund which holds a portfolio of securities is to purchase an ownership interest in that portfolio of securities. Investors are entitled to a 1 Rao, P. Hanumantha and Mishra, Vijay Kr., “Mutual Fund: A Resource Mobilizer in Financial Market”,

in Vidyasagar University Journal of Commerce, Vol. 12, March 2007, p. 111. 2 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,

http://www.sec.gov/investor/pubs/inwsmf.htm.

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pro rata share of dividends, interest and capital gains generated. Investors must also pay a pro rata share of the company’s expenses and its management fee, which will be deducted from the portfolio’s earnings as it flows back to the investors1. In U.S. mutual funds are subject to SEC registration and regulations, and are subject to numerous requirements imposed for the protection of investors. Mutual funds are regulated primarily under the Investment Company Act 1940 and the rules and registration forms adopted under that Act. They are also subject to the Securities Act of 1933 and the Securities Exchange Act of 1934. Mutual funds are either corporations or business trusts typically formed by an investment advisory firm that selects the board of trustee (directors) for the company. The trustees, in turn, hire a separate management company, normally the investment advisory firm, to manage the fund. The management company is contracted by the investment company to perform necessary research and to manage the portfolio, as well as to handle the administrative chores, for which it receives a fee2. American investors increasingly have turned to mutual funds to save for retirement and other financial goals. Mutual funds can offer advantages of diversification and professional management. But, as with other investment choices, investment in mutual funds involves risk. And fees and taxes will diminish a fund’s returns. It pays to understand both the upsides and the downsides of mutual funds investing and how to choose products that match your goals and tolerance of risk3. U.S. SEC on his website published several educational literatures for investors’ education and learning. It has stated few key points to remember for mutual funds investing:

i) Mutual funds are not guaranteed by FDIC or any other governmental agency – even if you buy through a bank and the fund carries the bank’s name. You can lose money investing in mutual funds.

1 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 50. 2 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 56. 3 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,


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ii) Past performance is not a reliable indicator of future performance. So do not be dazzled by last year’s high returns. But past performance can help you assess a fund’s volatility over time.

iii) All mutual funds have costs that lower your investment returns. Shop around, and use a mutual fund cost calculator at www.sec.gov/investor/tools.shtml to compare many of the costs of owning different funds before you buy.

Some of the traditional and distinguishing characteristics of open end mutual funds include the following:

Investors purchase shares from the fund or investment company itself (or through a broker for the fund) instead of from other investors on a secondary market.

The price that investors pay for mutual fund shares is the fund's per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as sales loads).

Mutual funds generally create and sell new shares to accommodate new investors. In other words, they sell their shares on a continuous basis to new investors. There is no limit on their capitalization and keeps on changing every day.

Mutual fund shares are also "redeemable," meaning existing investors can sell their shares back to the fund or investment company at any time.

The investment portfolios of mutual funds typically are managed by separate entities known as "investment advisers" that are registered with the SEC (Regulator).

Every investment has advantages and disadvantages. But it's important to remember that features that matter to one investor may not be important to another. Whether any particular feature is an advantage for one will depend on one’s unique circumstances. For some investors, mutual funds provide an attractive investment choice because they generally offer the following features1:

1 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,


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Professional Management — Professional money managers research, select, and monitor the performance of the securities the fund purchases. Diversification — Diversification is an investing strategy that can be neatly summed up as "Don't put all your eggs in one basket." Spreading your investments across a wide range of companies and industry sectors can help lower your risk if a company or sector fails. Some investors find it easier to achieve diversification through ownership of mutual funds rather than through ownership of individual stocks or bonds. Affordability — Some mutual funds accommodate investors who don't have a lot of money to invest by setting relatively low amounts for initial purchases, subsequent monthly purchases, or both. Liquidity — Mutual fund investors can readily redeem their shares at the current NAV — plus any fees and charges assessed on redemption — at any time. But mutual funds also have features that some investors might view as disadvantages, such as: Costs Despite Negative Returns — Investors may have to pay sales charges, annual fees, and other expenses regardless of how the fund performs. And, depending on the timing of their investment, investors may also have to pay taxes on any capital gains distribution they receive — even if the fund went on to perform poorly after they bought shares. Lack of Control — Investors typically cannot ascertain the exact make-up of a fund's portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades. Price Uncertainty — With an individual stock, you can obtain real-time (or close to real-time) pricing information with relative ease by checking financial websites or by calling your broker. You can also monitor how a stock's price changes from hour to hour — or even second to second. By contrast, with a mutual fund, the price at which you purchase or redeem shares will typically depend on the fund's NAV, which the fund might not calculate until many hours after you've placed your order. In general, mutual funds must calculate their NAV at least once every business day, typically after the major exchanges close.

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Despite these disadvantages, investors in U.S. other European countries choose to invest with mutual funds more aggressively especially household investor because their advantages have overcome their disadvantages in long run. Now mutual funds have are of first choice of them when it comes to investing. Now it is concluded that when it comes to investing, most of the western household investors opt for mutual funds. But investors have literally thousands of choices. Before you invest in any given fund, decide whether the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is figuring out your financial goals and risk tolerance — either on your own or with the help of a financial professional. Once you know what you are saving for, when you will need the money, and how much risk you can tolerate, you can more easily narrow your choices. Mutual funds are generally categorized broadly in the following:

Money Market Mutual Fund Equity (Stock) Fund Bond Fund Hybrid (Balanced) Fund

Money market fund invests in short-term high quality investments issued by the U.S. government, U.S. corporations, and state and local governments. They generally try to keep their NAV at a stable $1.00 per share. Money market funds are appealing to the U.S. investors for the following reasons:

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 Interest is credited on daily basis Diversification and professional management 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

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performance of the stock market. Equity funds are generally divided into two categories based on their approach to selecting stocks1:

Value fund generally seeks to find stocks that are cheap on the basis 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 of issued by both U.S. 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. Investors can earn money from mutual funds in three ways:

1. Dividend Payments — A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.

2. Capital Gains Distributions — The price of the securities a fund owns

may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.

3. Increased NAV — If the market value of a fund's portfolio increases

after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

1 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 61.

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With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment, or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an additional sales load)1. Let us jot down some words regarding the growth of mutual funds in U.S. markets. The growth in the number of mutual funds and the assets they hold is an incredible story. The number of mutual funds has grown rapidly in recent years. In 1980, there were 564 funds; at the beginning of 1997, there were approximately 7,000 funds, and in January 2006, there were approximately 8,000 domestic funds. The reason for this great growth includes investor demand for funds and low barriers to entry into the business. Consider this fact – more than 80% of all equity and hybrid funds and 60% of all bond funds, were started after 19912. Assets growth has also been dramatic, as shown in figure 1. Assets of mutual funds were relatively small for many years but exploded in 1990s. The top 25 mutual fund complexes account for about three-fourths of total mutual fund assets3.

Figure 1: 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment Company Industry, p. 9.

1 1 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,

http://www.sec.gov/investor/pubs/inwsmf.htm. 2 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 62. 3 Ibid.

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U.S. registered investment companies play a significant role in the U.S. economy and world financial markets. These funds managed more than $10 trillion in assets at the end of 2008 for 93 million U.S. investors. Funds supplied investment capital in securities markets around the world and were among the largest group of investors in the U.S. stock, commercial paper, and municipal securities markets1. Paul F. Roye, Director Division of Investment Management, U.S. Securities & Exchange Commission, addressed about mutual funds in his speech “Mutual Funds – A Century of Success; Challenges and Opportunities for the Future” at The Securities Law Development Conference, ICI Education Foundation, Washington D.C. on December 9, 1999:

It is not an overstatement to suggest that the 20th century, from the perspective of the American investor, was the century of the mutual fund. The changes that took place in the investment management industry over the past 100 years were dramatic.

There are many reasons for this success. I think we would all agree, however, that this could not have been accomplished without the regulatory framework that helped ensure the integrity of the industry.

The Investment Company Act of 1940 is credited with establishing a legal framework that both allowed for creativity in the development of the industry and guarded against its inherent abuses. After enactment of the Investment Company Act, assets of mutual funds tripled between 1941 and 1945, in spite of a World War.

That confidence continues today and has revolutionized our financial markets. The fund industry has become a trustee of the nation's savings. At the same time, the influence of mutual funds on the securities markets continues to grow. Mutual funds, including closed-end funds, today own nearly 17% of the value of all equity securities trading in the United States – more than any other type of institutional investor. The size and importance of the fund industry has broad implications for the average investor, as well as the global economy.

1 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment

Company Industry, p. 7.

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Taking about the completion and new products, he said:

The industry is experiencing a wave of consolidation so as to provide "one stop shopping" for the investor on a global scale. These developments are likely to affect competition within the industry, as well as give rise to new conflicts of interest that will have to be addressed by the funds and their advisers, as well as regulators.

The fund industry is responding to this competition with new approaches of its own. According to the same study, over $82 billion dollars are invested in mutual fund wrap accounts. The study also predicted an annual growth for this product of about 30% over the next two to five years.

Taking about learning the lessons from the past, he said:

Learning from the past is one of the keys to doing well in the future. If I have learned one thing over the past year as the IM Division Director, it is that the mutual fund industry is tremendously creative.

Mutual funds are attractive to investors because of the benefits of diversification, economies of scale and the access to professional money management. But just as important to mutual fund investors is the transparency of daily mutual fund pricing and investors ability to redeem or exchange shares when circumstances dictate.

Taking about full disclosure, he said:

As important as the substantive regulation of mutual funds has been to their success, many would also agree that another reason for the fund industry's success in the second half of this century was that investors "knew what they were buying." Not surprisingly, many of our recent regulatory efforts have focused on fund disclosure.

An important aspect of understanding a mutual fund is understanding its fees and expenses. Earlier this year, we introduced the Mutual Fund Cost Calculator – the first of its kind – on the Commission's web-site. Its popularity seems to reach to all corners of the world – an article in The Irish Times recommended it to the Republic's financial regulators.

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Emphasizing on technology, he said:

The Commission and the fund industry have begun to use the Internet to educate and further empower investors. In the century to come, perhaps no other force will have a greater effect on all aspects of fund operations – as well as financial markets generally – than technology. Already, the Internet has virtually deleted geographic boundaries, redefined the ways in which consumers and businesses interact, and altered many long-standing market relationships.

We are entering the "e-century," which will present both opportunities and concerns for the fund industry and its regulators. The possibilities for new services and products that could be made available with the Internet technology probably are limitless. So are the possibilities for fraud, security breaches, and privacy violations. A complicating factor in all of these developments is the speed with which technology keeps changing and new issues arise.

There is probably not a person in this room whose firm does not have a web-site. Fund groups also are beginning to offer investors the ability to do transactions on-line. Legislation currently pending in Congress would permit the use of electronic signatures, a development that could lead more fund groups to offer on-line services. As investors gain the ability to purchase and redeem fund shares with a few keystrokes, however, new pressures will be put on the funds' ability to plan for and meet redemptions.

This speech of SEC dignitary clearly depicts the role and growth of the mutual funds in the U.S. economy for the past 100 years. The role of technology has made them more transparent and easily available and accessible investment vehicle for everyone. A person who does not know about investing, can easily get educated by himself by extracting information through websites of the investing companies. Let’s talk about some interesting statistics of mutual funds in U.S. According to the data released by ICI (American Research Firm) on its website (www.ici.org) the net assets under management as at June 30, 2008.

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(billions of dollars)

Type of Funds June 08 May 08 % chg Dec 07

Stock Funds 5,838.9 6,341.2 -7.9 6,521.4

Hybrid Funds 675.0 711.6 -5.1 713.4

Taxable Bond Funds 1,373.4 1,375.0 -0.1 1,305.1

Municipal Bond Funds 384.2 387.0 -0.7 373.8

Taxable Money Market Funds 2,909.8 2,972.3 -2.1 2,642.1

Tax-Free Money Market Funds 496.8 503.4 -1.3 465.1

Total 11,678.1 12,290.5 -5.0 12,020.9 Table 1: Source Investment Company Institute website (http://www.ici.org/stats/mf/trends_06_08.html)

Number of Mutual Funds in this Report Type of Funds June 08 May 08 June 07 Stock Funds 4,838 4,824 4,704 Hybrid Funds 498 496 477 Taxable Bond Funds 1,290 1,294 1,292 Municipal Bond Funds 651 654 687 Taxable Money Market Funds 550 549R 562 Tax-free Money Market Funds 257 257 262 Total 8,084 8,074 7,984 Table 2: Source Investment Company Institute website (http://www.ici.org/stats/mf/trends_06_08.html)

From the data given in Table 1, despite reduction in assets in June 2008 as compared to May 2008, the entire mutual fund industry in U.S. still managed to hold more than $11 trillion with it in various fund categories. Above table is also showing that the investors are more interested and bullish in Stock Funds than any other category. Now look at the mutual funds worldwide. According to the data released by ICI on its website, the mutual funds assets are decreased by 12.4%. The collection contains the data of 44 countries. The figure 2 shows a decline in the fourth quarter due to financial crisis but still there is a huge amount of $18 trillion is under management.

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Figure 2: Worldwide Mutual Funds Assets (Trillion of U.S. Dollars) Source: Investment Company Institute website (http://www.ici.org/stats/mf/ww_12_08.html)

From the figure 3 below, at the end of the fourth quarter of 2008, 34 percent of worldwide mutual fund assets were held in equity funds. The asset share of bond funds was 18 percent and the asset share of balanced/mixed funds was 9 percent. Money market fund assets represented 31 percent of the worldwide total.

Figure 3: Other/unclassified includes the total net assets of Ireland and Netherlands. Source: ICI website (http://www.ici.org/stats/mf/ww_12_08.html)

As evident from figure 4 below, by region, 56 percent of worldwide assets were in the Americas in the fourth quarter of 2008, 33 percent were in Europe, and 11 percent in Africa and Asia/Pacific.

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Figure 4: Source ICI website (http://www.ici.org/stats/mf/ww_12_08.html)

The number of mutual funds worldwide stood at 68,574 at the end of the fourth quarter of 2008. In figure 5 it is shown that by type of fund, 41 percent were equity funds, 21 percent were balanced/mixed funds, 18 percent were bond funds, and 5 percent were money market funds.

Figure 5: Other/unclassified includes total funds in Ireland. Source: ICI website (http://www.ici.org/stats/mf/ww_12_08.html)

Table 3 shows the year wise net assets reporting of different courtiers with showing 2008 in each quarter. Table 4 shows the total number of funds from which the data is collected.

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Total Net Assets, 2003-2008:Q4 Billions of U.S. dollars, end of periods

2003 2004 2005 2006 20072008

Q1 Q2 Q3 Q4All Reporting Countries1 14,048 16,165 17,771 21,823 26,151 24,807 24,649 21,645 18,967

Equity 5,923 7,219 8,333 10,508 12,446 10,605 10,437 8,618 6,525

Bond 3,047 3,313 3,450 3,871 4,277 4,221 4,184 3,793 3,399

Money Market 3,206 3,323 3,364 3,864 4,961 5,615 5,591 5,424 5,791

Balanced/Mixed 1,198 1,445 1,566 2,049 2,632 2,495 2,476 2,159 1,776

Other 311 398 512 676 884 885 975 823 679

Countries Reporting in Every Period2 13,300 15,246 16,731 20,333 23,981 22,697 22,645 19,936 17,422

Equity 5,766 7,031 8,123 10,226 11,827 10,075 9,979 8,238 6,239

Bond 2,953 3,217 3,339 3,755 4,119 4,050 4,018 3,646 3,259

Money Market 3,157 3,254 3,289 3,769 4,812 5,460 5,440 5,277 5,619

Balanced/Mixed 1,128 1,364 1,485 1,927 2,367 2,255 2,260 1,975 1,636

Other 296 380 495 656 856 857 947 801 669Table 3: Source: Investment Company Institute (www.ici.org) 1 Components may not sum to total because of rounding or unclassified funds. 2 Number of countries is 25. Components may not sum to total because of rounding.

Number of Funds, 2003-2008: Q4

2003 2004 2005 2006 20072008

Q1 Q2 Q3 Q4All Reporting Countries1 54,569 54,982 56,868 61,855 66,350 67,220 68,513 69,496 68,574

Equity 22,688 22,362 23,264 25,698 27,319 27,284 27,627 28,108 27,882

Bond 11,886 13,309 13,231 13,571 13,306 12,961 12,662 12,575 12,214

Money Market 4,974 3,623 3,536 3,409 3,452 3,562 3,721 3,703 3,701

Balanced/Mixed 11,465 11,603 11,393 12,530 13,756 13,973 14,390 14,686 14,510

Other 1,578 1,997 3,317 4,116 5,619 6,538 7,144 7,383 7,170

Countries Reporting in Every Period2 41,689 42,354 42,427 45,394 47,661 47,520 48,031 48,878 58,104

Equity 20,018 19,918 20,044 21,805 22,449 22,156 22,324 22,659 23,950

Bond 9,847 9,961 10,004 10,292 10,241 9,876 9,674 9,718 10,956

Money Market 2,652 2,899 2,799 2,663 2,635 2,724 2,858 2,822 3,142

Balanced/Mixed 7,857 8,095 7,857 8,540 9,737 9,826 10,142 10,580 13,210

Other 1,315 1,481 1,723 2,094 2,599 2,938 3,033 3,099 6,846Table 4: Source: Investment Company Institute (www.ici.org) 1 Components may not sum to total because of unclassified funds.

2 Number of countries is 24.

The above statistics in table 3 and table 4 are very encouraging about the future of mutual funds investing. The total number of mutual funds has

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increased by 31% and net assets have increased by 33% from 2003 to 2008. Equity funds have the highest share among the others. The statistics also reveals the level of competition for mutual fund in U.S. market. There are more than 600 organizations in U.S. that offers mutual funds and other investment services and products. Historically, low barriers to entry have attracted a large number of investment company sponsors to the fund marketplace in the United States. These low barriers to entry led to a rapid increase in the number of fund sponsors in the 1980s and 1990s. However, competition among these sponsors and pressure from other financial products have reversed this trend. About 400 fund advisers left the fund business over the period 2000 to 2008; in the same time, about 300 new firms entered1 (figure 6).

Figure 6: 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in

the Investment Company Industry, p. 13.

They are continually competing with each other to attract investors. Investors prefer funds with low fees and expenses and have a performance of average or above average. Investment companies also held the largest share of U.S. commercial paper, an important source of short-term funding for major U.S. and foreign corporations. Money market funds account for the majority of funds’

1 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the

Investment Company Industry, p. 12.

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commercial paper holdings, and the share of outstanding commercial paper these funds hold tends to fluctuate with investor demand for money market funds and the overall supply of commercial paper. During the second half of 2007 and early 2008, when money market funds had strong cash inflows, their holdings of commercial paper rose, along with their holdings of Treasury and agency securities, certificates of deposit, and other money market instruments1. Households are the largest group of investors in funds, and registered investment companies managed 19 percent of households’ financial assets at year-end 2008 (figure 7). This share is down from 2007, reflecting the drop in the value of stocks held in equity and hybrid funds. Nevertheless, the share of household assets held in funds remained above levels seen in the early 1990s. As households have increased their reliance on funds, their demand for directly held stocks and bonds has grown more slowly. For example, over the period 2004 to 2008, households purchased, on net, a total of $2.4 trillion in mutual funds (including through variable annuities), ETFs, and closed-end funds, while they sold $2.5 trillion of directly held stock (figure 8). Much of this shift by households toward funds has been through net purchases of mutual funds2.



1 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the

Investment Company Industry, p. 11. 2 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment


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The large number of fund sponsors and the dynamic nature of the financial services market have kept market concentration of the largest fund sponsors stable for the last 15 years. Approximately 93 million of U.S. investors, with a wide range of financial objectives and services and service needs, currently own mutual fund shares. Shareholders demand for performance is one the most widely documented competitive forces. Numerous academic papers have demonstrated that the best performing funds receive most of the net new cash inflow. Investors also pay attention to fund services. Mutual funds offer a broad range of services s competition drives them to innovate and offer new and better services1. Investment companies have been among the largest investors in the domestic financial markets for much of the past 15 years and held a significant portion of the outstanding shares of U.S.-issued stocks, bonds, and money market securities at year-end 2008 (figure 9). Investment companies as a whole were the largest group of investors in U.S. companies, holding 27 percent of their outstanding stock at year-end 20082.

1 Investment Company Institute, U.S.A. (www.ici.org) 2 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment


25

Figure 9: 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment Company Industry, p. 11.

In 2008, an annual ICI (U.S.A.) survey of mutual fund ownership revealed that 52.5 million, or 45.0 percent, of households in the United States owned mutual funds. This report highlights the following characteristics of those households1. In 2008, most households that owned mutual funds were headed by individuals in their peak earning and saving years. About two-thirds of mutual fund–owning households were headed by individuals between the ages of 35 and 64. In this age the saving and investing traditionally is the greatest. Mutual fund–owning households often held several funds, and equity funds were the most commonly owned mutual fund, held by 80 percent of mutual fund–owning households (Figure 5). In addition, 38 percent owned hybrid funds, 48 percent owned bond funds, and 66 percent owned money market funds. Mutual fund holdings represented a significant portion of these

AGE OF HEAD OF HOUSEHOLD1

Mean: 49 years

Median: 49 years TYPE OF MUTUAL FUND OWNED2

1 Investment Company Institute, USA, Annual Mutual Fund Shareholder Tracking Survey, 2008.

Younger than 35,

17%

34 to 44, 22%

45 to 54, 26%

55 to 64, 20%

65 or older, 15%

80%

38%48%

66%

6%

0%

30%

60%

90%

Equity Funds Hybrid Funds Bond Funds Money Market Funds

Others

26

households’ financial assets: 69 percent had more than half of their household financial assets invested in mutual funds. Almost three-quarters of the mutual funds owning households were married or living with a partner. Almost one-half had the college degrees or postgraduate education. Almost all mutual fund investors were focused on retirement saving. Saving for retirement was one of the household’s financial goals for 95 percent of mutual fund–owning households. Employer-sponsored retirement plans are increasingly the gateway to fund ownership. About two-thirds of fund-owning households that purchased their first fund in 2000 or later purchased that fund through an employer-sponsored retirement plan, as compared to about half of those that made their first purchase before 1990. In 2008, about two-thirds of mutual fund–owning households owned funds inside employer sponsored retirement plans. Almost three-quarters of mutual fund–owning households held funds outside of employer-sponsored retirement plans. The majority of mutual fund owners was employed and had moderate household incomes. More than three-quarters of individuals heading households owning mutual funds were employed either full- or part-time.

MUTUAL FUNDS’ SHARE OF HOUSEHOLD FINANCIAL ASSETS3

MARITAL STATUS OF HEAD OF HOUSEHOLD1

EDUCATION LEVEL OF HEAD OF HOUSEHOLD1

EMPLOYMENT STATUS OF HEAD OF HOUSEHOLD1

25% or less, 13%

26% to 50%, 18%

51% to 75%, 24%

Greater than 75%, 45%

Single, 10%

Married or living with a partner,

76%

Divorced or

separated, 8%

Widowed, 6%

High School or Less, 25%

Associate's degree or

some college,

29%

Completed college,

20%

Some graduate school or completed graduate school,

26%

Employed full time,

68%

Employed part time, 5%

Retired and employed

full time, 2%Retired and employed

part time, 3%

Retired and not

employed, 17%Not

employed, 5%

27

Mutual fund–owning households often hold more than one mutual fund. In 2008, the median number of mutual funds owned by shareholder households was four. Among these households, 41 percent owned three or fewer funds, and 59 percent owned four or more, with 13 percent reporting they held 11 or more funds. Mutual fund–owning households have a variety of financial goals for their mutual fund investments. The vast majority, 95 percent, indicated they were using mutual funds to save for retirement; 76 percent indicated that saving for retirement was their household’s primary financial goal. Retirement is not the only financial goal for households’ mutual fund investments. Fifty-two percent of mutual fund–owning households reported that reducing their taxable income was one of their goals; 45 percent listed saving for an emergency as a goal; and 25 percent reported saving for education among their goals. Note: 1. Head of household refers to the sole or

co-decision maker for household saving and investing.

2. Multiple responses are included.

3. Household financial assets include assets in employer-sponsored retirement plans, but exclude the household’s primary residence.

4. Total reported is household income before taxes in 2007.

TOTAL HOUSEHOLD INCOME4

Mean: $98,000

Median: $80,000 NUMBER OF MUTUAL FUNDS HOUSEHOLD OWNS

Mean: Six funds

Median: Four funds FINANCIAL GOALS FOR MUTUAL FUND INVESTMENTS2

PRIMARY FINANCIAL GOAL FOR MUTUAL FUND INVESTMENTS2

Table 5: Source: Investment Company Institute, Annual Mutual Fund Shareholder Tracking Survey, 2007

Less than $ 25,000,

5%

$25,000 to $34,999, 5%

$35,000 to $49,999, 12%$50,000 to

$74,999, 21%

$75,000 to $99,999, 20%

$100,000 or more, 37%

One, 14%

Two, 14%

Three, 13%Four, 14%Five to Six,

17%

Seven to Ten, 15%

Eleven or more, 13%

6%

10%

19%

25%

45%

52%

95%

Other

House or other large item

Current Income

Education

Emergency

Reduce Taxable Income

Retirement

Education, 6%

Current Income, 5%Emergency,

5%

Reduce Taxable

Income, 4%

House or Other Large

Item, 2%

Other, 2%

Retirement, 76%

28

Growth in the investment companies brings unmatched developments for the economy of both the developed and under developed countries. They not only stabilize the investment market providing best alternatives for investment for both institutions and household investors; but they also provide employment in the economy which is one of the greatest features. They provide literature on their products which is also very useful to educate a novel investor. In U.S., based on results of a biannual survey, fund sponsors added more than 21,000 workers to their payrolls between 2005 and 2007, reaching a record 168,000 employees (figure 10). Fund sponsors provide advisory, recordkeeping, administrative, custody, and other services to a growing number of funds and their investors1.

Figure 10: 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity

in the Investment Company Industry, p. 16.

Mutual funds in U.S. are not only the source for employment but majority of the households in U.S. opt for mutual funds for their various needs including savings and investment, retirement plans and education. They are so easy to invest that an individual can get a direct access to any investment company and can invest with them without any hassle. The literature provided by them is also very easy to understand. They provide efficient tool for institutions including nonfinancial institutions for cash management and alternative investment vehicle for both short-term and long-term. Huge portions of employers managed retirement plans are invested with mutual funds. Financial advisors of investment companies 1 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the

Investment Company Industry, p. 16.

29

provide advisory services and suggesting strategies to a large number of households to meet financial goals. In short mutual funds in U.S. are considered as an indispensable tool for the future of the investment climate and as per the statistics mentioned above, also for the future of the huge number of households. Mutual funds in underdeveloped countries like in Pakistan are still in its developmental phase and the market is very nascent unlike Americas where they are at their peak. In Pakistan, investment companies depend largely on the institutional money and very small number of households is investing with them. Households who have invested are majority related to these financial institutions itself or they are highly educated. 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) and public offering of NIT which is an open end fund. In 1966 another company Investment Corporation of Pakistan (ICP) was established which offered a series of 26 closed end mutual funds. In 2002, government started the privatization of ICP and ABAMCO Limited acquired 12 funds of ICP (ABAMCO was later acquired by Jahangir Siddiqui & Company). Rest of the funds were acquired by PICIC Asset Management Company Limited. Initially there was both public and private sector participation in the management of these funds, but with the nationalization in the seventies, the Government role become more dominant. Later, the government also allowed the private sector to establish mutual funds. Currently there are more than 120 mutual funds with more than 30 AMCs at the end of Financial Year 2008. In the last few years mutual fund industry has shown significant progress with reference to saving mobilization and important part of the overall financial markets. But still we are far behind the developed countries mutual fund industry. Growth in mutual funds worldwide is because of the overall growth in both the size and maturity of many foreign capital markets. These nations have increasingly used debt and equity securities rather than bank loans to finance economic expansion. The Pakistan economy can prosper because of

30

the benefits of new investment opportunities arising from economic reform, privatization, lowered trade barriers and rapid economic growth1. Individuals throughout the world have the same basic needs that are education for their children, health, good living standard and comfortable retirement. In our country where people are religious minded, mostly they avoid bank schemes for investments, if they are provided an investment opportunity which suits the religion, we can mobilize savings from masses which may be laying an idle money at present. By doing so we would be able to improve the living standard of our countrymen through economic prosperity. This can be achieved through the introduction of different species of mutual funds and their performance. The success of this sector depends on the performance and the role of regulatory bodies. Excellent performance and stringent regulations will increase the popularity of mutual funds in Pakistan2. In Pakistan, mutual funds are subject to the approval and authorization by Securities & Exchange Commission of Pakistan (SECP) and listing at any of the Stock Exchanges of Pakistan. They are regulated under the Companies Act 1985, NBFC Rules 2000, NBFC Rules and Regulations 2003 and Notified Entities Regulations 2007. In Pakistan mutual fund is constituted as a trust. It has a Trustee, Sponsor, Asset Management Company (AMC), Registrar (Transfer Agent) and Custodian. Fund is established by Sponsors who appoints the Asset Management Company which is authorized by SECP; and Trustee who holds the property of the fund in its custody for the benefit of the investors and hence acts as a custodian as well. AMC appoints Registrar or Transfer Agent who is responsible for keeping the data of all the investors either electronically or on paper. SECP authorizes the scheme and permits the Asset Management Company, being a regulator, to carry out the investment activity after listing at any Stock Exchange. All the investments will be done in a fund according to the guidelines provided by the SECP. SECP in its Circular No. 07 of 2009 ref: NBFCD/MF/CIRCULAR/2009/292 in consultation with Mutual Funds Association of Pakistan3 (MUFAP) had devised the following categories for the open end schemes: 1 Aamir Shah, S.M. and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in

The Pakistan Development Review 44:4 Part II, Winter 2005, p. 865. 2 Ibid, p. 866. 3 MUFAP is an association which has a membership of entire AMC of Pakistan established to

safeguard the interest of the mutual funds industry.

31

1. Equity Scheme 2. Balanced Scheme 3. Asset Allocation Scheme 4. Fund of Funds Scheme 5. Shariah Compliant (Islamic) Scheme 6. Capital Protected Scheme 7. Index Scheme / Index Tracker Scheme 8. Money Market Scheme 9. Income Scheme 10. Aggressive Fixed Income Scheme

In Pakistan, mutual funds are providing same facilities to their investors including liquidity, professional management, diversification, low cost and other benefits being an open end. They are also the major source of employment in our economy. Let’s examine the history of our country in respect of mutual funds. Most people believe that Pakistan has been slow in the developing a mutual fund market. This is not exactly true. In 1962, the government launched NIT unit funds which were public sector open-end mutual funds. This was quite early for such a step by international standards and made us one of the world leaders in this industry. Then, for 33 years, the industry just stagnated. It was like we took a 30-year break1 (figure 11). In 1995 the private sector started to launch mutual funds and the AMC2 industry has only grown from there to well over 30 AMCs today. Why is it that the mutual fund industry as a whole, in Pakistan, taken so long to develop? At the time of launch of NIT, there were 81 listed companies (figure 11) with market capitalization of Rs. 1.9 billion as compared to today’s market where the total listed companies have increased to 677 with a market capitalization of Rs. 4.3 trillion. The early 60s were a boom time for Pakistan and people were looking to set up new business.

1 Speech by Tara Uzra Dawood – CEO DCM, Emerging Investment Solutions, at IBA 2 Asset Management Company, synonym for Investment Company in this context.

32

Figure 11: Dawood Capital Management Limited Research.

Unfortunately, this boom was followed by a period of tension with our neighbor that has led to conflict which culminated in the independence of East Pakistan as Bangladesh. Approximately 60 companies out of the 318 listed on the Karachi Stock Exchange in 1971 were de-listed here, and listed in Dhaka (figure 11). Wars are not good for business, especially when they are so close to home. They create an outflow of money to a “Safe-Haven” environment and stifle re-investment. To make matters worse, nationalization followed further hurting growth prospects, as the same people that were eager to set up their businesses were reluctant to re-invest and even after this era of nationalization ended, and once again the safe option was to get the money they had earned out of the country in to a safe haven. Add to this mix, political instability and corruption and you have a recipe for stagnation. First and foremost Pakistan does not save as much as its neighboring developing countries. Our domestic savings rates as a ratio of GDP was 9.1% in 1987 and today is still not above 10%, according to the article “savings in Pakistan: growth and organization”. Household savings are very hard to measure in Pakistan because of non availability of concrete data. India and Thailand’s citizens savings is over twice that figure while Sri Lanka, Myanmar and Egypt are over 50% stronger in savings than Pakistan1. Over 100% of the GDP in North America is invested in this sector, over 20% in India and less

1 Speech by Tara Uzra Dawood – CEO DCM, Emerging Investment Solutions, at IBA

1581

291 314

487

762

655

0

100

200

300

400

500

600

700

800

1950 1960 1970 1980 1990 2000 2010

Com

pani

es

Number of Companies Listed on the Stock Exchange

NIT

1962

Pvt. AMC

1995

33

than 1% in Pakistan, although this is still a very new investment option in our country1. There is also the cultural aspect to consider. We are generally not “a nation of savers”2. Just look at a wedding that takes place in Karachi or any other part of the country. The key is to “impress”. We hardly ever plan, those who use a credit card and worry about the payment later. It is no wonder that we lost our way. This can be shown in graphic terms in figure 12.

Figure 12: We are not “A Nation of Savers”

There are a number of factors why the savings rates are so low in Pakistan. It includes extravagance and status-oriented demonstrations. Just look at how competitive our weddings and parties have begun even child’s birthday parties. There is also a mistrust of financial institutions, which led to great investment in real estate or jewelry rather than financial assets3. There is additionally a deep-seeded philosophy that Allah will give so why does one need to save for a rainy day. We agree that Allah will Inshallah give, but we also believe he helps those who help themselves and encourages us to get educated, work hard and work toward a better life4.

1 DCM Research and World Bank 2 Speech by Tara Uzra Dawod – CEO DCM, Emerging Investment Solutions, at IBA 3 Speech by Tara Uzra Dawood – CEO DCM, Savings in Pakistan, at Rotary Club, Beach Luxury Hotel,

September 2, 2005 4 Ibid

34

Savings is actually one of the most exciting and freeing things we can do in our life. As we build a nest egg, we build ourselves opportunities and choices for the future. As economy teaches us “investment is the function of savings”, mutual funds provide savings and investment options for everyone belongs to any class of the society. Mutual funds are higher yielding alternatives than bank accounts and other government savings schemes and extremely liquid – anyone can withdraw his/her money anytime without penalty with just 3-6 days notice. They are available in low-medium-high risk profiles depending on the investors risk tolerance and their short-term and long-term needs. Further, mutual funds have many tax benefits that appeal to high income earnings since individuals gain a tax credit for the amount they invest in mutual funds. Many mutual funds especially, money market funds offer very low minimum amount of investment to start which encourages the investors of low income brackets to go for mutual funds. There is a strong correlation between savings and quality of life. Let’s compare Pakistan with two similar countries – Malaysia and South Korea1. a. In 1960, we three countries were at the same level of economic

development. Today, both Malaysia and South Korea are economic tigers, while we are not.

b. One reason is they have saved their way to prosperity. They have a much

stronger ratio of gross domestic savings to gross domestic product.

i. Pakistan has never been above 20% ii. South Korea approx. 29% iii. Malaysia 47.2%, 2005 This means they save more money every year and have more financial security.

c. So how does this correlate with their quality of life?

1 DCM Ltd. Research and World Bank

35

i. Well, let’s examine their human development index, or HDI, which is an excellent barometer of quality of life as it takes into account health, education, standard of living and so forth.

Figure 13: Dawood Capital Management Limited Research and World Bank

ii. HDIs of below 0.5 are considering low category countries and include

many African countries

iii. HDIs of 0.5 to 0.5999 like Pakistan are considered medium category.

iv. South Korea and Malaysia, however, fall in the high category of above 0.8.

v. There definitely seems to be a correlation between this HDI or quality of life index and savings rate in a country.

vi. Pakistan ranked in this same report above Mauritania but below Ghana at 136 in terms of HDI.

d. It is important to remember at this point that these countries are very

similar to ours and South Korea, in particular, has faced many wars and they even originally took our – yes our – economic model.

Now let’s move toward the industry itself. Let’s examine these figures more closely, what exactly are the assets under management of mutual funds in Pakistan. Mutual funds have made a spectacular growth in the past three years. Asset under management as on June 2002 were merely 25 billion which have

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Gross Domestic Savings as Percentage of GDPKorea, Rep. Malaysia Pakistan

36

increased substantially over the years and as on June 2006, these stood at Rs.175 billion, as on June 2008 Rs. 300 billion (USD 4 billion) and as at December 2008 Rs. 175 billion (USD 2.1 billion)1. There is a massive reduction of approximately 40 percent, due to the financial crisis which hurt the mutual funds the greatest. Compare this to India’s approximately USD 63 billion as at December 20082, we are a long way behind. There are twenty eight Assets Management Companies/Investment Advisors registered with Mutual Funds Association of Pakistan. These companies are currently managing 121 open and closed end mutual funds. The private sector is playing an increasingly prominent role in the sector and currently holds about 50 per cent of the total industry size. However, with the impeding privatization of NIT (a public sector company) holding 50 per cent of the total industry size, the mutual fund industry will become the exclusive domain of the private sector. This moving of mutual fund industry into the private sector is a very healthy sign for the future of the industry. It would boost its growth and new people will come into the market which will be beneficial for its well being3. So why are not we investing more in mutual funds and how will economic growth is expedited if we now start investing more in these instruments. First, we have not been investing much in mutual funds as a nation because of our historical and cultural opinions on savings. Further, many people believe:

1. Mutual funds are focused on the corporate market since all over the world; there is a great focus on corporate investors.

2. For individual investors, we view mutual funds generally as a short-

terms savings or parking option, without fully realizing what savings even means to our lives and to the economic growth of our country.

Let’s examine the cycle of the mutual fund to understand how investing in mutual funds affect/improve quality of life, economic growth and social welfare. 1 MUFAP Sources 2 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the

Investment Company Industry, p. 167 3 MUFAP , Country Report Pakistan 2007.

37

Investment by mutual funds in Term Finance Certificates (TFC), Corporate Bonds, Commercial Paper or more recently Sukuks (Islamic TFC) fuels economic growth and adds to social welfare (figure 14). Approximately Rs. 42 billion has been invested by mutual funds in debt instruments as at December 2008, according to the DCM research team based on fund manager reports in the industry.

Figure 14: Mutual Fund Cycle, DCM Research

While you see your personal investment savings grow according to the typical mutual fund process, your large or small investment has made a difference. You may not be able to pinpoint that brick in the factory that is contributing to the economic growth or the square foot of tar on the road, as yours, but collectively, you have made a difference to the economic growth and social welfare. When a company issues a TFC, Sukuk or Commercial Paper (debt instrument), the major portion is purchased by mutual funds who have the money of institutions and households. Indirectly investors of mutual funds become the investors of these issues. Hence, mutual funds are providing the medium / bridge between corporate who are in need of money and investors

38

who are in need of good investments i.e. a bridge between deficit and surplus agent. The money received by these companies are utilized in extending the business and production activities which in turn generates more employment opportunities. Out of the profits earned, companies pay taxes to the authorities which are spent on the welfare and infrastructure development. When companies pay off the profits to these mutual funds who holds their debt instruments, indirectly these are transferred to the investors and their economic welfare is increased and their demand for further consumer items will increase as well. Everyone talks about the future of how many assets mutual funds are managing, but the real benefit to a nation’s economic growth is the investments the mutual funds make in debt instruments that have built and continue to build our country. These investments not only help build the factories, hotels and infrastructure of our nation, but they create jobs for Pakistanis including you and me. Mutual funds also help stabilize the stock market.

Figure 15: Mutual Funds as a Stock Market Stabilizer

39

When you invest in an IPO for example, after the launch, your shares are vulnerable to market ups and downs. The company itself, however, is not really concerned about share prices, other than for rights issues or raising future funds. So you as an investor are very much at risk. So, who stabilizes and supports your market. It’s a mutual fund! When you invest with stock fund, they invest in the share market. They help to stabilize their prices which in turn increase the valuation of the issuing companies. In turn, the companies may be able to issue TFCs on good terms and it’s again a mutual fund who will buy those TFCs and whole cycle starts again. Its means mutual funds stabilize the market in dual way. While the data earlier has pointed out the deficiencies in our savings habits, it is also worth looking at what constitutes savings in Pakistan. Perhaps because of need for security, we prefer banks as our savings option. It is something we are familiar with and we are comfortable with it, regardless of whether it is actually better of us to save with a bank. If you were to go out today, and ask 100 people what a bank deposit is, I am pretty sure that the response would be accurate from about 99% of your sample. Ask you sample group what a mutual fund is, and I would hazard a guess that the number would be in the 10% region, and of that 10% that has an idea, perhaps 50% of those would say, “it’s something to do with the stock market isn’t it?”1 Perhaps it’s our agrarian nature, we value land, and land has served us well to a great degree. But as this table shows, mutual funds present a far superior saving option in most instances to the “traditional”.

Table 6: DCM Research 1 Speech by Tara Uzra Dawood – CEO DCM, Emerging Investment Solutions, at IBA

NoNoNoYes

No (1)YesNo

No (1)NoNo

BANK TERM DEPOSITS REAL ESTATE

ORDINARY SHARES

TERM FINANCE CERTIFICATES

MUTUAL FUNDS

Yes (SECP)Yes

No (3)YesYesNoYesNoYesYes

Yes (SBP)YesYesNoNoYesYesYesNoYes

Yes (SECP)NoNoYesYesNoNoNoNoYes

Penalty for early withdrawals Add DiversificationDaily Pricing

Trustee Fixed Rate of returnsTax Advantage

Regulated by Govt. Authority

Easy to buy and sell Long Term CommitmentManaged by Professionals

Yes (SECP)YesYesNoNoYesNo

Yes (2)NoNo

40

Bank deposits, our preferred means of savings, do not offer tax advantages, are not easy to get out of and there is a penalty if you break your deposit. Land, which is what we believe in, is not only out of reach for most savers in Pakistan in terms of affordability. It is also very difficult to buy or sell, simply because of the amount involved in purchases, and the costs associated with buying and selling land. Shares. A lot of people here will invest in the stock market directly. You have to ask yourself, what is my career focus on, and do I have the time to follow the market as well as a professional fund manager can with all the resources that are at their disposal. TFCs are included because they are often the choice of investments for corporate entities. TFCs do not offer any of the advantages over mutual funds other than fixed return and regulation by the SECP to the corporate investor. Here is the paradox; a corporate investing in a mutual fund will reap the benefits of investing in TFCs without the liquidity constraints of direct investment in a TFC. One question you may be asking is why would you invest in a mutual fund instead of a bank account? The major difference between a mutual fund and bank deposit is that your bank deposits will serve the bank shareholders and the bank itself. You, the depositor, will not make extra if the bank does well. Mutual funds by law have to distribute over 90% of their profits to investors. Investors in banks only get as small share in their contribution to economic growth. Investors in mutual funds, however, get the full fruit of all profits made. Investment in a mutual fund not only offers benefits to the saver, but also the corporate sectors. The fund, money market or equity, can help the corporate sector meet its financing needs, and in the process pass the benefits along to their investors. For these reasons the asset under management were increased in mutual funds as compared to percentage of bank deposits every year (figure 16). After 2007, it was declined in June 2008 and December 2008 due to the financial crisis and households including institutions withdrew money from the

41

mutual funds in bulk amounts. It was followed by the freeze of the stock market which locked up the liquidity of the investors and they had no choice except to redeem their holdings from the mutual funds to meet their liquidity requirements.

Figure 16: SBP Economic Data and DCM Research

So far we have been talking about how our contribution to savings can have an impact on the nation. But what about the impact savings can have on our life as an individual. Warren Buffet1, advised a graduating class to do the same and instead.

“Stay away from credit cards and invest in yourself” A billionaire American entrepreneur, who has never owned a credit card – it may sound ridiculous, but it is a fact. Warren Buffet has never owned a credit card. He chose to invest in himself. Borrowing is a double edged sword when it comes to the economy. While the credit facilities available spur the economy, perhaps faster than through savings, the fact remains us is part of the credit bubble. By being part of the bubble, we are driving the economy; we are helping car manufacturers, mobile phone makers and service providers etc. But all the time we are being drawn further in to the center of the bubble2.

1 Warren Buffet, second richest man in the World, till he donated $31 billion to charity. 2 Speech by Tara Uzra Dawood – CEO DCM, Emerging Investment Solutions, at IBA

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

Jun-2002 Jun-2003 Jun-2004 Jun-2005 Jun-2006 Jun-2007 Jun-2008 Dec-2008

Ban

k D

epos

its P

KR

. Bill

ion

AU

M a

s %

of B

ank

Dep

osits

Open-End Mutual Fund v/s Bank Deposits

Bank Deposits Pkr. Bln. AUM as % of Bank Deposits

42

As we all know, we are not a nation of exporters, so this credit bubble is also contributing to the balance of payments deficit we run. We want consumer goods and we want them now. These days, the increasing innovation in products is helping to cater to the requirements of all types of investors – risk averse, return orientated as well as Shariah Complaint investors now having a large array of products to choose from. However, the industry is still in the dire need of more or different products in the market to address the different trends/preferences of the investors. Moreover, the State Bank of Pakistan now allows mutual funds to invest 30 per cent of their assets abroad or US $ 15 million (whichever is lower)1. This initiative will allow fund managers to diversify their portfolios which will mitigate risk and enhance investor confidence in mutual funds2. These days, the MUFAP is playing an active role in the promotion and growth the industry. The governing regulator, SECP has setup a stringent regulatory framework for the industry and with the recent amendments in the NBFC Rules (Notified Entities Rules 2007), the regulator has become more vigilant in light of the ever increasing number of mutual funds and asset management companies coming into the market. The mutual fund industry already meets stringent standards in terms of how funds conduct their business. For example, it is mandatory for all assets management companies and their funds to acquire a rating, while weekly reporting of assets and liabilities of funds is also required. Moreover, the trustee structure, governed by NBFC Rules 2003 and 2007, ensures that the custody of all assets in the funds is held with the trustee on behalf of the investors. The trustee structure provides yet another independent safeguard for the investors. Despite the substantial progress made by Pakistan’s mutual funds industry during the past 3-4 years and strong regulatory presence, Pakistan’s mutual funds industry is still in the early stages of development. The industry still needs to do a lot more to be able to attain a comparable position at least with the mutual funds industry in India let alone those in the developed world.

1 MUFAP, Country Report Pakistan, 2007 2 Ibid

43

The Pakistani investors are though gradually learning to use mutual funds as a channel to the capital markets but there is still a long way to go to boost their confidence to attract further investment for economic gains and prosperity in the country. The industry needs to market itself and also to launch an aggressive awareness program particularly for retail investors to educate them about the risk factor and also about the different products. So far AMCs/IAs has successfully tapped the corporate sector but the vast potential in the retail segment has been largely untapped. Presently, many investors, individuals in particular, are satisfied with placing their savings into bank account. Returns from bank deposits are well below the prevailing inflation rate. In real terms, therefore, bank deposits are providing negative returns, which in turn dilute an investor’s purchasing power1. Starting a mutual fund investing is very simple and easy. Because of the transparency provided by the mutual funds, all the time we know, our money, our savings are generating a return for us – not a third party. Our mutual fund or savings plan earns its coming to us. Finally, there is the issue of variable returns in the mutual fund. Do not fear them. Traditionally mutual funds have proved a far better savings option than a traditional fixed rate bank deposit. Even if we are investing in a very conservative savings plan the returns are generally higher than term deposit rates on offer. Even if you invest in an aggressive savings plan, most if not all stock markets rise in the long term, so do not be rattled by short term volatility. The reality is that by investing in ourselves, we are making a difference to the development of Pakistan, and very simply, making our life easier. Getting out of this spending now paying later habit and to the savings habit means our life will be actually more enjoyable as we are not trying to service a credit bubble we have been sucked in to. Investing in mutual funds and the development of this industry is critical to our national development. We need to shift our thinking and work together to understand that savings and investing in mutual funds is not just about making a quick buck. It's about making a difference to the country, to the economy and to our own future2.

1 MUFAP, Country Report Pakistan, 2007 2 Speech by Tara Uzra Dawood – CEO DCM, Emerging Investment Solutions, at IBA

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CHAPTER III

SUMMARY

45

CONCLUSION

From the review, it has been concluded that mutual funds are the important

source of investment for both the households and institutions. They are the

key to success for any economy including western developed societies and

under developed societies like ours. They are one of the easiest mode of

investing which provides to the investors the fruits of diversification,

professional management and risk reduction which any individual cannot get

with its limited resources. They are most important tool for capital formation

for any economy.

In west they have proved by their performance and they have success stories

of last hundred years. It has not only encouraged the small household

investors to start savings but also at the same time increased their welfare

and economic well being.

In under developed countries like Pakistan, it is still in the stage of

development and the market is very nascent. Regulators and association in

collaboration with AMCs are doing their best to provide good investment

market with prudent regulatory framework to not only provide efficient

investment but also safeguard the capital and benefits of the investors.

Mutual Funds Industry in Pakistan is at present set to takeoff to new heights.

But to achieve this, concerted and sustained efforts are required both from the

stakeholders and the regulators. At present, they are playing their due role for

the growth and development of the industry. The government is taking a

series of measures to provide the necessary conducive working environment

whereas the stakeholders/operators of the industry are striving hard to create

the requisite awareness about the mutual funds among the masses through

media, training programs etc. and also by developing their reputation and

maintaining good records. If these efforts are made on regular basis, it is

hoped that the mutual funds industry in Pakistan will be able to achieve the

desired results in medium to long term.

46

RECOMMENDATIONS

Current financial crisis has shaken the investors’ confidence from the capital

markets which had 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 participators of the industry seem inadequate to restore

the investors’ confidence. In fact, their measures (including freeze of stock

market and equity funds) engendered confusion.

This industry had a very successful period during 2006 and 2007. They were

managing all time high assets under management. But now that situation is

changed. The assets under management are dropped to more than half. It is

true that the values are bottomed out but at the same time the probability of a

rebound is also reasonably high.

The participants should take certain steps to more educate the investors

especially retail and households and provide awareness about their

investment products through advertisements, media, training programs etc. as

it is observed that funds focusing on retail clientele emerged stronger. They

should strive hard to provide more conducive environment to the investors.

The size of the mutual funds sector 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.

While selling the code of ethics should not be ignored. Misrepresentation by a

sales agent is also a major reason for this set back. 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.

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Currently there is a lack of investments avenues, therefore, AMCs have to

invest in long term illiquid investments. Regulator and association with

collaboration with investment companies should provide enough invest

avenues in the market to cater the increasing needs of the investments. 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, our

economy may able to post success stories like west.

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BIBLIOGRAPHY

49

1. Rao, P. Hanumantha and Mishra, Vijay Kr., “Mutual Fund: A Resource Mobilizer in Financial Market”, in Vidyasagar University Journal of Commerce, Vol. 12, March 2007.

2. Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and

Exchange Commission, http://www.sec.gov/investor/pubs/inwsmf.htm. 3. Jones, Charles P. (2005-06), Investments Analysis and Management,

10th edition, California. 4. 2009, Investment Company Fact Book, 49th Edition, A Review of Trends

and Activity in the Investment Company Industry. 5. Investment Company Institute, U.S.A., website, www.ici.org 6. Investment Company Institute, USA, Annual Mutual Fund Shareholder

Tracking Survey, 2008. 7. Aamir Shah, S.M. and Hijazi, Syed Tahir, “Performance Evaluation of

Mutual Funds in Pakistan”, in The Pakistan Development Review 44:4 Part II, Winter 2005.

8. DCM Research and World Bank 9. Speech by Tara Uzra Dawod – CEO DCM, Emerging Investment

Solutions, at IBA 10. Speech by Tara Uzra Dawood – CEO DCM, Savings in Pakistan, at

Rotary Club, Beach Luxury Hotel, September 2, 2005 11. MUFAP, Country Report Pakistan 2007. 12. MUFAP website www.mufap.com.pk.

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APPENDICES

Economy & Finance

MUTUAL FUNDS AND ECONOMY