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Mutual Funds in

Pakistan
Investors Education Seminar arranged by
SECP and ICAP held on 29th January 2015
Presented By First Capital Investments
Limited

Definition of Mutual Fund

A mutual fund is a collective investment scheme, which


specializes in investing a pool of money collected from
investors in various avenues.

The purpose is investing in securities such as stocks,


bonds, money market instruments and similar investment
products.

Mutual funds can be divided in to two classes:


Conventional Mutual Funds and Islamic Mutual Funds.

Structure of a Mutual Fund


Unit holders

Holding of units

Dividends
Custodian on behalf of
unit holders

Management Fee

Asset
Management
Company

Mutual Fund
Management Services

Trustee
Trustee fees

Ownership of assets

Net Income

Investments

Establishment Mechanism

Mutual Funds are managed by Asset Management Companies


(AMCs) which exists in the form of a public limited company
registered under the Companies Ordinance, 1984.

A new fund is established through execution of a Trust Deed,


between an AMC and a Trustee, upon an approval from SECP under
the Non-Banking Finance Companies (Establishment and Regulation)
Rules, 2003.

The Trustee performs the functions of a custodian for the assets of


the Fund. The trustee also ensures that the Fund Manager takes the
investment decisions within the defined investment policy of the
mutual fund.

In Pakistan, banks and central depository companies, approved by


SECP, can act as trustee.

Establishment Mechanism

At present Central Depository Company of Pakistan (CDC) is


acting as Trustee for the most of the funds.

SECP is the regulator of mutual fund industry and is very


vigilant in issuing licenses to the Asset management companies.

SECP also carries out continuous monitoring of mutual funds


and AMCs through off site and on-site inspections.

Mutual Funds are regulated by NBFC & NE Regulations 2008.

Objectives of investing through Mutual


Funds

By investing in mutual funds, investors' worries are taken care


by fund managers/asset managers.

Mutual funds give small investors access to professionally


managed, diversified portfolios of equities, debt instruments i.e.
TFCs and Govt. Securities and other securities, which
otherwise would be quite difficult to create with a small
amount of capital.

Fund Managers are backed by a dedicated research team, who


are involved in investment decisions based on the performance
and prospects available in the market.

Benefits of Investing in Mutual Funds

Accessibility: Mutual funds units are easy to buy.

Liquidity: Unit holders can convert their units into cash on any
working day. They will promptly receive the current value of their
investments. The fund buys back (redeems) the units.

Diversification: By investing the pool of unit holders money


across number of securities, a mutual fund diversifies its holdings. A
diversified portfolio reduces the investors risk.

Professional Management: Asset Management Company


evaluates all the opportunities that arises in the market, carefully
examines them and then takes decision for investing the mutual
funds money whereas it is not an easy task for an individual and
even for corporate entity if investing is not their core business.

Importance of Mutual Funds

Mutual funds have an important role in the development


of the capital markets;

Economic parameters, such as savings, capital market


development, dispersal of corporate ownership and
corporate governance are directly related to the
development of mutual funds industry;

Mutual funds help in improving Corporate Governance.

Types of Fund
Open-end Mutual Funds
The Unit holders may buy or redeem the Units of the fund on a
continuous basis at the prevailing Net Asset Value (NAV). These
units are purchased and redeemed through Management
Company which announces offer and redemption prices daily
(working days).

Close-end Mutual Funds


These funds have a fixed size divided into shares like a public
company and are floated through an IPO. Once issued, shares can
be bought and sold at the market rates in secondary market
(Stock Exchange).

Categories of Funds
Equity Scheme
An equity scheme or equity fund is a fund that invests in Equities more
commonly known as stocks/shares. The objective of an equity fund is
long-term growth through capital appreciation, (sources of revenue are
dividends and capital gains).

Balanced Scheme
These funds provide investors with a single mutual fund that invests in
both stocks and debt instruments and with this diversification aimed
at providing investors a balance of growth through investment in
stocks and debt instruments.

Asset Allocation Fund


These Funds may invest its assets in any type of securities at any
time in order to diversify its assets across multiple types of securities
& investment styles available in the market.

Categories of Funds
Fund of Fund Scheme
Fund of Funds are those funds, which invest in other mutual funds. These
funds operate a diverse portfolio of equity, balanced, fixed income and money
market funds (both open and closed ended).

Shariah Compliant (Islamic) Scheme


Islamic funds are those funds which invest in Shariah Compliant securities
i.e. shares, Sukuk, Ijara sukuks etc. as may be approved by the Shariah Advisor
of such funds. These funds can be offered under the same categories as those
of conventional funds.

Index Tracker Scheme


Index funds invest in securities to mirror a market index, such as the KSE
100. An index fund buys and sells securities in a manner that mirrors the
composition of the selected index. The fund's performance tracks the
underlying index's performance.

Categories of Funds
Capital Protected Scheme
In this type of scheme, the payment of original
investment is guaranteed with any further capital gain
which may accrue at the end of the contractual term of the
Fund . Such funds are for a specific period.

Money Market Scheme


Money Market Funds are among the safest and most stable
of all the different types of mutual funds. These funds invest
in short term debt instruments such as Treasury bills and
bank deposits.

Categories of Funds
Income Scheme
These funds focus on providing investors with a steady stream
of fixed income. They invest in short term and long term debt
instruments like TFCs, government securities like T-bills/ PIBs, or
preference shares.

Aggressive Fixed Income Scheme


The aim of aggressive income fund is to generate a high return
by investing in fixed income securities while taking exposure in
medium to lower quality of assets also.

Breakup of Open end Mutual Funds


Net Assets of Open end Mutual Funds are PKR 387 Billion as
at 30 June 2014
Money Market 30.4%
Equity 23.0%
Income 16.1%
Islamic Income 9.5%
Islamic Equity 6.0%
Islamic Fund of Funds 3.2%
Aggressive Income 3.2%
Islamic Balanced 1.8%
Asset Allocation 1.7%
Islamic Money Market 1.3%
Balanced 1.0%
Islamic Capital Protected 0.8%
Fund of Funds 0.6%
Islamic Aggressive Income 0.6%
Islamic Index Tracker 0.3%
Islamic Asset Allocation 0.3%
IndexTracker 0.1%

Breakup of Closed end Mutual Funds


Net Assets of Closed end Mutual Funds are PKR 21 Billion

as at 30 June 2014

Equity 94.7%
Income 5.3%

Real Estate Investment Trusts (REITs)

Pension Schemes

These types of schemes offered long term saving plans for


retirement benefits.

Pension Saving Funds are managed by the professional Pension


Fund Managers (AMCs and Insurance Companies) who are
licensed by SECP.

Various types of sub funds are managed by Pension Fund


Managers in which investors are invited to invest according to
their risk appetite.

Income of pension scheme is exempted from income tax


under clause 57 (3)(viii) of Part 1 of the 2nd schedule.

Asset Management Companies

Mutual funds are managed by Asset Management


Companies, who are licensed by SECP, for a consideration
of Asset Management Fee.

Mutual funds' management company charge the


management fee that is capped at 2% (3% for initial five
years) by SECP.

Normally the Fund Management Companies charge 2%


fee for equity funds and upto 1.5% for fixed income and
cash funds.

Mutual Fund Industry in Pakistan

Despite of completion of half century of its existence industry


has not been able to achieve the desired level of development;

There are only 244,362 mutual fund accounts having assets


valuing Rs. 416 billion as on June 30, 2014 in a country with a
population of more than 180 million people;

The lower growth is largely due to historically low savings rate


in Pakistan, which is continuously declining.

According to latest figures, the estimated size of mutual fund


industry is Rs. 500 billion.

Mutual Fund Industry Size as compared


with GDP
Mutual Fund Industry Size as % of GDP

GDP (USD Billion)

Mutual Fund Industry


Size (USD Billion)

India

2047.81

180.088

8.79%

Pakistan

251.48

4.965

1.97%

Sri Lanka

71.57

0.948

1.32%

Bangladesh

186.59

0.644

0.35%

Year wise Growth of Asset Management


Companies and Funds
180
160
140
120
100
80
60
40
20

2005
Number of AMCs 16
Number of Funds
38

2006
20
48

2007
29
76

2008
26
97

2009
27
109

2010
28
135

2011
26
144

2012
27
159

2013
26
158

2014
21
170

Year wise Breakup of Growth of Funds


180
160
140
120
100
80

60
40
20
0

2005
Open-end Funds
19
Closed-end Funds 19
Pension Funds
0

2006
29
19
0

2007
49
23
4

2008
67
23
7

2009
81
21
7

2010
105
21
9

2011
118
16
9

2012
133
15
11

2013
138
9
11

2014
153
4
13

Growth Constraints for Mutual Funds in


Pakistan

Lack of awareness: Steps are required to promote


savings and investments through investors awareness and
education.
Number of Investors: With awareness, number of
investors will be increased.
Savings Rate: During FY 2014, the trends in term of
investment and private savings to GDP ratio declined
from 12.97% to 12.39% and 8.3% to 8.5% respectively
which is discouraging.
Taxation anomalies: There is need of removing the
taxation anomalies and regulatory issues which are
hampering the growth of mutual fund industry.

Returns of various types of Funds


Conventional Open-End Fund Returns
2010

2011

2012

2013

2014

Average

Equity

18.76%

25.04%

9.12%

56.42%

47.34%

31.34%

Index Tracker

29.79%

22.45%

7.33%

44.78%

35.37%

27.94%

Balanced

14.25%

16.38%

13.40%

36.65%

23.70%

20.88%

17.93%

12.19%

6.76%

23.42%

14.78%

15.02%

13.99%

31.70%

14.69%

35.93%

9.93%

21.25%

9.44%

11.02%

11.08%

9.73%

9.32%

10.12%

10.63%

11.85%

11.16%

9.05%

8.18%

10.17%

8.40%

-2.12%

1.45%

8.14%

5.88%

4.35%

7.22%

9.71%

3.27%

11.38%

0.00%

6.32%

-17.14%

0.00%

-8.57%

Asset
Allocation
Fund of
Funds
Income
Money
Market
Aggressive
Income
Capital
Protected
Commodity

Returns of various types of Funds


Islamic Open-End Fund Returns
2010

2011

2012

2013

2014

Average

Islamic Equity

29.25%

37.23%

19.97%

47.94%

28.72%

32.62%

Islamic Balanced

16.82%

27.17%

16.24%

25.00%

28.25%

22.70%

-2.34%

49.64%

26.49%

24.60%

Islamic Index
Tracker
Islamic Asset
Allocation
Islamic Aggressive
Income

10.24%

13.82%

8.31%

30.80%

16.01%

15.84%

1.01%

1.35%

10.19%

7.81%

12.96%

6.66%

Islamic Income

8.07%

10.08%

10.98%

9.37%

8.74%

9.45%

10.10%

10.98%

10.69%

8.06%

8.70%

9.71%

6.26%

6.08%

6.17%

13.52%

10.45%

3.68%

11.17%

Islamic Money
Market
Islamic Fund of
Funds
Islamic Capital
Protected

14.07%

14.12%

Risk factors in Mutual Funds

Mutual funds do not provide a guaranteed return, like


fixed deposits, bonds and Government securities,

Mutual Funds returns are directly related to performance


of the underlying investments.

Investment in mutual funds are subject to various risks


which includes Market Risk, Liquidity Risk, Credit Risk,
Interest Rate Risk, Country Risk and Currency Risk.

Tax Credits
Unit Holders of mutual funds, other than an entity, shall be
entitled to a tax credit under Section 62 of the Income Tax
Ordinance 2001 on purchase of new Units. The amount on
which tax credit will be given shall be lower of:
(a) amount invested in purchase of new Units; or
(b) Twenty percent of the taxable income of the Unit Holder; or
(c) Rupees One Million (Rs 1,000,000);

and will be calculated by applying the average rate of tax of the


Unit Holder for the tax year. If the Units so acquired are
disposed within twenty four months, the amount of tax payable
for the tax year in which the Units are disposed shall be
increased by the amount of credit allowed.

Growth of Equity Market in Pakistan


Pakistan Market: Historical Returns for last 11 years
Year

KSE-100 (Rs.)

KSE-100
(US$)

MSCI Pakistan
(US$)

2004

39%

34%

9%

2005

54%

53%

56%

2006

5%

3%

-2%

2007

40%

38%

33%

2008

-58%

-67%

-75%

2009

60%

51%

78%

2010

28%

26%

19%

2011

-6%

-10%

-17%

2012

49%

38%

23%

2013

49%

38%

27%

2014

27%

33%

8%

Average

26%

22%

14%

Taxation

Two principles govern the taxation of mutual funds. First,


there is tax-neutrality principle that states that for
investors, whether they invest directly in securities or
through mutual funds it should be tax neutral;

Second, there is a pass-through principle that states that


mutual funds being pass-through entities are not subject
to tax; investors to mutual funds are subject to income
tax and capital gains tax.

Various Taxation and Regulatory Issues


being faced by Mutual Fund Industry

Tax issues:
Levy of Workers Welfare Fund (WWF) to Mutual Funds
despite these funds have no employees;
Sales Tax on Asset Management Services Provincial
Jurisdiction Conflicts;
Federal Excise Duty (FED) on Asset Management
Services, which amounts to double taxation;
Regulatory issues:
Unnecessary delays in granting various approvals to Asset
Management Companies and changes required on various
Laws like REIT Regulations.

Future Outlook:Equity Market

Pakistan Equities look geared for another year of stellar returns with KSE-100
Index target of 40,000 points by December 2015 (an upside of 16.00% from the
existing level of 34,500 level), in view of the following factors:

A) continued macroeconomic de-risking as economic indicators are improving;


B) Declining Oil Prices transport services and commodity prices:
C) Reducing Interest Rates benefit to the leveraged companies;
D) Growing political maturity foreign investors confidence;
E) Authorities refocusing on Economic Reforms power;
F) Infrastructure Development;
G) Stable domestic currency & Inflationary outlook:
H) Cost of capital will incorporate the decline in principle lending rates which will expand the
Equity valuations;
I) Political stability as all parties front a unified stand in the wake of recent terrorism

The market continues to offer a dividend yield of 6%, the highest amongst the
regional markets. KSE-100 P/E of 8.9x at CY15 earnings is at around a 40%
discount of regional peers.
As return drops from debt based instruments, equity market will witness higher flows.

Future Outlook:Debt Market

With the start of BATS, it is expected that the debt market


will grow in Pakistan. However, due to cut on interest rates,
the growth of fixed income instruments like PIBs, T-Bills,
Bonds, TFCs will be limited.

Debt markets have already started responding to falling


inflation expectations and improving macroeconomic outlook
as yields on long-term bonds (3-10 years) have declined by
around 300bps in the last quarter of the CY14.

Yield on the debt instruments to remain subdued in CY15 due


to soft inflation outlook, further cut in discount rate, restricted
budget deficit and higher government borrowing from external
sources.

Future Outlook:Pakistans Economy

Despite of energy crises, the countrys growth trajectory moving towards 6.5% in view of the various
factors discussed in Equity and Debt Market outlook. (FY15 and FY16 GDP growth was estimated at 5.1%
and 6.0%, respectively)

Inflation CPI is expected to remain in the range of 4.5% - 5.5% during FY15 from earlier expected 8.00%.

Further monetary easing given lower CPI and widening real interest rate.

Disbursement of IMF tranche to unlock further flows from other multilateral agencies.

Current Account Deficit to GDP for the period ended Jul-Dec 2015 clocked in at 0.9% as against the
projected target of ranging 1-1.2% of GDP.

Privatization process to remain on track with focus shifting towards divestment of Governments stake in
loss making entities.

Government targeted fiscal deficit is 4.5% of GDP in FY 2015 as against 4.7% in FY 2014.

Political stability as all parties front a unified stand in the wake of recent terrorism.

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