Mutual Funds

A mutual fund company is an investment company that receives money from investors for the
sole purpose to invest in stocks, bonds, and other securities for the benefit of the investors. A
mutual fund is the portfolio of stocks, bonds, or other securities that generate profits for the
investor, or shareholder of the mutual fund. A mutual fund allows an investor with less money to
diversify his holdings for greater safety and to benefit from the expertise of professional fund
managers. Mutual funds are generally safer, but less profitable, than stocks, and riskier, but more
profitable than bonds or bank accounts, although its profit-risk profile can vary widely,
depending on the fund's investment objective.

It is easier to pick an investment strategy, such as growth or income, with mutual funds than by
buying the individual securities, since mutual fund companies clearly specify the investment
objectives of each fund that they manage. Other advantages to investing in mutual funds is that
the initial investment is generally low, it is easy to reinvest profits, and money can be invested
continually, often in amounts less than the initial investment, such as every month. It can even be
done automatically.

Mutual Fund Companies

Mutual fund companies are investment companies registered under the Investment Company Act
of 1940.

Investment Adviser

Funds are managed by an investment advisor or by professional money managers under

contract with the fund to invest to achieve the specific investment objectives of the fund, such as
growth or income. The investment advisor, who could be officers of the fund or a management
company, makes the daily investment decisions for the fund, and the fund's success largely
depends on their ability.

The initial contract is for 2 years, and must be approved by the board of directors and the
shareholders. Afterwards, the contract must be renewed annually by the approval of the board of
directors or the shareholders.
The prospectus lists the name of the investment adviser, their location, the term of their contract,
and their principle duties and responsibilities. Their typical management fee is ½% of the funds
assets.

Board of Directors

Every investment company must have a board of directors, with no more than 60% of the board
consisting of insiders, and at least 40% consisting of individuals who have no affiliation with the
company, the fund's investment adviser, its underwriter, or any organization related to these
entities.

Although the outside representation may be in the minority, several important decisions
regarding the fund require the majority approval of the outsider representation to prevent
conflicts of interest.

Custodian

A custodian, usually a bank, holds the money and securities in trust, and handles the
relationships with the investors, such as sending the monthly financial statements and proxy
forms for voting. It has no part in the investment choices or decisions of the fund.

Management Companies
The companies that operate mutual funds are called management companies in the Investment
Company Act, and are classified as:

1. open-end investment companies—commonly called mutual fund companies—which

offers shares continuously and stands ready to redeem them,
2. and the closed-end investment company, which makes a 1-time offering of shares, which
are securities that can be traded like stock, but the company does not redeem the
securities.

Open-End Mutual Funds

Most mutual funds are open-end funds, which sells new shares continuously or buys them back
from the shareholder (redeems them), dealing directly with the investor (no-load funds) or
through broker-dealers, who receive the sales load of a buy or sell order. The purchase price is
the net asset value (NAV) at the end of the trading day, which is the total asset of the fund
minus its liabilities divided by the number of shares outstanding for that day.
Net Asset Value Formula

Total Assets - Total Liabilities

Net Asset Value =

Number of Outstanding Shares

The number of shares of an open-end fund varies throughout its existence, depending on how
many shares are bought or redeemed by investors.

A major disadvantage to open-end funds is that they need cash to redeem their shares for
investors who want out, so they either have to have a lot of cash on hand, which earns only the
current prevailing interest rate, or they have to sell securities to raise the cash, possibly
generating capital gains taxes for the remaining investors of the fund.

In Pakistan there exists 34 open ended mutual funds (as of 2006) including National Investment
(Unit) Trust (NIT) in the public sector and Atlas Income Fund, Crosby Dragon Fund and
Faysal Balanced Growth Fund.

Closed-End Mutual Funds

Closed-end mutual funds, also known simply as close-end funds (CEFs), sell their shares in an
initial public offering (IPO), based on an advertised investment objective, such as for income or
growth. The proceeds of the sale are then used to buy securities based on that investment
objective. The CEF shares represent an interest in the portfolio of securities held by the closed-
end investment company. The shares have a net asset value, just as open end mutual funds, but
the closed-end investment company does not redeem the shares. Instead, the shares are traded on
a stock exchange, just like stocks. Usually, when the shares are first offered, they are sold at a
premium to their NAV. However, in the secondary market, the shares often sell at a discount to
their NAV, because share price depends on the supply and demand of the market. Since there is
no method available to exchange CEF shares for their underlying securities, arbitrage cannot be
used to equalize the CEF share price to its NAV.

In Pakistan there exist 22 close ended mutual funds (as of 2006) in cluding
A l - Meezan Mutual Fund, Asian Stocks Fund and ABAMCO Composite Fund.
Evaluating a Mutual Fund
When a mutual fund is created, the founders decide what market strategies to pursue and its
investment objectives. A required prospectus is prepared for potential investors that details the
company's objectives, expenses, fees, and management, so that an investor can make an
informed decision about the mutual fund. When an investor buys the shares of the mutual fund,
he becomes a shareholder of the company, with basically the same rights and privileges as a
shareholder of any other company.

Fees
Mutual funds come in two main flavors, categorized by how the fees are charged.

A load mutual fund charges you for the shares/units purchased plus an initial sales fee. This
charge is typically anywhere from 4% to 8% of the amount you are investing or it can be a flat
fee depending on the mutual fund provider. This is added to your purchase as a sales fee. For
example, if you invested $1,000 into a 5% load mutual fund, you would actually be investing
only $950 with the remaining $50 going to the company as a commission.

There are a couple different types of load funds out there. Back-end loads mean the fee is
charged when you redeem the mutual fund. A front-end load is the opposite of a back-end load
and means the fee is charged up front. A no-load fund simply means that you can buy and
redeem the mutual fund units/shares at any time without a commission or sales charge.

There are numerous fees associated with specific activities, the total of which can vary from .5%
to 8.5%, the legal maximum. Management fees are annual charges for administering the fund,
which can vary from about .5% to 2%. Distribution and service fees (12b-1 fees) cover
marketing expenses to bring in new investors, and may be used to pay bonuses for employees.
Redemption fees, sometimes referred to as a deferred sale load or back load fees, are assessed
when shares of the fund are sold, to discourage frequent trading, unless the investor has held the
shares for a minimum of time, specified in the prospectus. Reinvestment fees can be charged if
the investor reinvests his profits in the fund. Exchange fees can be charged if an investor
transfers his money from one fund to another within the same company.

Measuring Mutual Fund Performance

A mutual fund can be measured in various ways. Three common metrics are:
1. Net Asset Value (NAV) change. The NAV is the share price of the fund, obtained by dividing
the value of the fund's holdings by the number of outstanding shares. The share price is what you
would have to pay to buy into the mutual fund, plus any fees. The change in NAV, reported at
the end of every market day, reflects the increase or decrease in the value per share.

Net Asset Value (NAV) Formula

Value of Fund

Net Asset Value (NAV) =

Number of Shares

Net Asset Value (NAV) Example

$100,000,000 total fund value

= $10 per share

10,000,000 shares

Investing in a Mutual Fund

Buying Mutual Fund Shares

An investor has a choice of buying shares of the mutual fund directly, or through a financial
agent, such as a broker or a bank. Buying through an agent will generally cost more, and
oftentimes, an agent will push funds that his company sponsors or earns the highest commission
for the agent rather than what’s best for the client. There are, however, good tools on the Web for
finding funds that satisfy certain criteria.

Profiting from a Mutual Fund

A mutual fund earns money from dividends and interest, and by selling securities. Profits are
paid to investors through distributions. Income distributions are based on profits from
dividends and interest, while capital distributions are from profits from the sale of securities.
The schedule of payouts differs according to company. Typically, income is distributed
quarterly, while capital distributions are paid out once a year, usually in December.
Instead of receiving distributions, profits can be reinvested, but investors must pay tax on
profits, whether it is distributed or reinvested. Income distributions are taxed as ordinary income,
while capital distributions are taxed as capital gains.

An investor can also profit by selling shares back to the fund—redeeming the shares. Such sales
are taxed as capital gains in the year they are sold. Depending on the mutual fund and the share
class, there may be a deferred sales load on the redemption.

An Overview of the Different Types of Mutual Fund

Money Market Mutual Funds

Money market funds are all no-load funds, and pay dividends daily, though they may only be
credited monthly. Their income generally reflects short-term interest rates, because by law, their
investments are restricted to certain high-quality, short-term investments issued by the U.S.
government, U.S. corporations, and state and local governments. According to SEC Rule 2A-7,
a 1997 addition to the Investment Company Act of 1940, money market funds shall limit their
portfolio investments to those United States dollar-denominated securities that the fund's board
of directors determines to present minimal credit risks.

Net asset value (NAV) is maintained at about $1.00 per share, which is possible because these
funds pay out all of their income as dividends. But the NAV may fall below $1.00 if the fund's
investments perform poorly. Most of them have check-writing privileges, though there may be a
minimum amount for the check. Taxable funds buy higher yielding short-term corporate or
federal issues. Tax-free funds buy municipal debt.

Money market funds have low risks, but unlike money market bank accounts, money market
mutual funds are neither insured nor guaranteed by the FDIC. Historically the returns for money
market funds have been lower than for either bond or stock funds. That's why inflation risk —
the risk that inflation will outpace and erode investment returns over time — is a risk with these
funds. Capital losses have been rare, but are possible.

Bond Funds

Bond funds are based on bonds, but they have no maturity date and no guarantee of repayment
of principal. Bond funds benefit investors because the initial investment is less than the
minimum $5,000 or more for bonds, and, like other funds, it allows easier and greater
diversification by having a collection of different bond types, such as investment-grade
corporate, junk, government, sector, international, gold and precious metals, and other
categories; and different bond maturities.

In some funds, management is free to change categories as the changing markets warrant.

Tip: When interest rates rise, the NAV of bond funds declines because bond prices decline as
interest rates rise, and vice versa, and so goes the total return of the fund. Thus, a bad time to buy
a bond fund is when interest rates are rising, and a good time to buy is when they are declining.

Taxable funds buy corporate and federal bonds.

Tax-free funds buy municipal bonds. No federal tax, and no state or local tax if investor lives in
the municipality.

Although bond funds are generally safer than stock funds, they do have risks:

 Credit risk is the risk that issuers whose bonds owned by a fund may fail to pay their
debts. Such risk is inversely related to the credit rating of the issuer. Thus, there is
virtually no credit risk with U.S. Treasuries, little risk with investment-grade bonds, and
great risk with junk bonds.
 Interest-rate risk arises from the possibility that interest rates will rise, thereby
decreasing the value of bonds in the secondary market. Such risk can even reduce the
value of Treasury bonds. The longer the bond term, the greater the risk. However, since
interest rates don't vary that much, this risk is relatively small compared to the price
swings of stocks.
 Prepayment risk increases as interest rates decline, increasing the likelihood that the
bond issuer will call the bond in early to issue new bonds at the lower prevailing interest
rate. Although, like interest rate risk, this risk is minor, it will lessen a fund's future
income, unless the company is willing to buy bonds with a higher credit risk.

Stock Funds
Although a stock fund's short-term value is volatile, because prices depend not only on the
economy, but also on the underlying business, stocks usually outperform other types of
investments over the long term.

Different kinds of stocks are chosen for their risk and potential profit:

 Income funds invest in stocks that pay regular dividends.

 Index funds buys stocks in a particular index, with the proportion of each stock
proportional to the weight of that stock in the index.
 Blue-chip funds provide income and relative safety compared to small-cap stocks.
 Growth funds have a greater chance of significant appreciation, because they are based
on small-cap, undervalued, or out-of-favor companies.
 Value funds are based on companies that some believe are undervalued, and thus, have a
greater appreciation potential and greater safety.
 Cyclical funds invest in stocks that rise and fall with the economic cycles. Some
businesses are heavily dependent on discretionary spending, such as airlines and hotels.
When the economy is strong, these businesses do better as more people spend money for
luxury items, thus, their stocks rise; when the economy is weak, people cut back on
spending that isn't necessary, thus lessening the earnings of these businesses, and
reducing their stock prices.
 Sector funds invest in a particular industry, such as the medical field or technology. The
increased potential for returns is proportional to the increased risk that results from
limited diversification in a volatile investment.

Balanced Fund

A mutual fund that buys a combination of common stock, preferred stock, bonds, and short-
term bonds, to provide both income and capital appreciation while avoiding excessive risk.
The purpose of balanced funds (also sometimes called hybrid funds) is to provide investors
with a single mutual fund that combines both growth and income objectives, by investing in
both stocks (for growth) and bonds (for income). Such diversified holdings ensure that these
funds will manage downturns in the stock market without too much of a loss; the flip side, of
course, is that balanced funds will usually increase less than an all-stock fund during a bull
market. Balanced Funds are appropriate for investors who do not wish to take excessive risk
and at the same time are also seeking capital appreciation.

Meezan Balanced Fund

Meezan Balanced Fund is a Shariah Compliant open-end balanced scheme. It is a tool that
provides exposure to both Equity and Debt markets through a single fund. The earnings are
generated by potential capital appreciation and regular income. Meezan Balanced Fund (
previously a closed end balanced scheme ) was converted into an open-end balanced fund
with effect from July 1, 2013.

Investment Objective & Philosophy

The Fund seeks to generate long term capital appreciation as well as current income by
creating a balanced portfolio that is invested both in high quality Shariah compliant equity
and Income Instruments.

MBF is positioned as a relatively lesser risky alternative to a pure equity fund, while
retaining the potential upside from equities portion together with stable income from Shariah
compliant fixed income instruments. Hence making it less risky and less volatile than pure
equity funds – moreover this helps MBF deliver steady returns across various market cycles.

Investment Growth

If you invested Rs. 100,000 in MBF at the time of launch in December 2004, the value of
your investment has increased by 406% to reach Rs. 506,000 as on Sep 30, 2015.

Islamic Funds
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.

Type of Islamic funds

Commodities

Commodities funds generate profits by buying and reselling Halal commodities. Because of
the restrictions on the use of derivatives, commodities fund make use of two types of Shariah
approved contracts:

Istisna- It’s a contract where the buyer of an item funds upfront the production of the item. A
detailed specification of the item has to be agreed before production starts and the cost of
production can be paid partially according to manufacturing stages.

Bay al-salam- It’s similar to a forward contract where the buyer pays in advance for the
delivery of raw materials or fungible goods at a given date. The spot price of the item
includes the profit of the person who has taken the task of purchasing good and, of course,
the cost of the product.

Equity funds

Funds that invest in common shares in companies engaged in halal business. Companies are
also screened in order to check for Shariah compliant accounting principles. Because of the
limited pool of companies the funds can invest into, equity funds can have higher volatility
compared to similar funds in the same space.

Murabaha

They are similar to development funds, also referred to as ‘cost-plus’ financing, where a fund
will buy goods and resell them to a third party at a given price. The price is made of the cost
of goods plus a profit margin. Cost and margin are agreed in advance.

Ijara

Funds that acquire and keep ownership of an asset (real estate, machinery, vehicles or
equipment) and then makes profits by leasing it out in return of a rental payment. The fund is
responsible for the management of the asset and will normally receive a management fee.
The leased item must be used in a Halal manner