Lec# 03 Learning Goals

• Mutual Funds
• Open ended vs Close ended
• Types of mutual funds
• Performance evaluation of mutual funds
• Fundamental vs Technical analysis
• The efficient market hypothesis (EMH)

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 Mutual Funds
• These are institutional investors that pool the resources of
investors and manage these assets professionally.
• Some people will invest in equity, some in bond and some in
Islamic funds.
• These investors are called unit holders of equity fund and bond
fund.
• First mutual fund in Pakistan was introduced in 1962, named
NIT (National Investment Trust)
• NIT is an open ended mutual fund and is the largest mutual fund
of Pakistan.
• In 1968, a close end mutual fund was introduced namely ICP
(Investment Corporation of Pakistan).
• Mutual funds are regulated by SECP not by SBP.

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 Open ended Fund

• Funds whose units are sold and can also be

repurchased
• Due to this its capital is not fixed
• Its units are not traded on stock market.
• It is called open ended because path of return to
already sold units is open.

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 Close Ended Fund

• Fund that sell units to investors and not

repurchase them.
• It has fixed capital.
• Its units are traded on stock market.
• It is called close ended because path of returning
units to fund is closed.

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 Types of Mutual Funds
Equity Funds: those funds that invest in equity securities only.
• Also called growth funds.
• Long term investors invest in equity funds e.g., PICIC growth
fund
• Equity funds are further categorized into three:
– Large cap:
• companies having market capitalization of 10 billion dollars or more .
• Low risk low return
– Mid cap:
• companies having market capitalization of 1 – 10 billion dollars.
• Average size
– Small cap:
• companies having market capitalization of less than $1 billion
• Opportunity for high growth as well as failure
• High risk high return

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 Types of Mutual Funds
Income funds: those funds that invest in fixed income securities
only (e.g., bonds)
• Short term liquidity investors invest in income funds
• People who are not interested in long term growth and want fixed
income after a specific period, so their interest is not price
appreciation
• Example,. Pakistan income fund
Balance funds: those funds that invest in equity as well as in fixed
income securities.
• They tend to have more risk than fixed income funds, but less risk than pure
equity funds. Aggressive funds hold more equities and fewer bonds, while
conservative funds hold fewer equities relative to bonds.
• E.g., Alfalah Balance Fund

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 Types of Mutual Funds
Money market funds: those funds that invest in money market
instruments (i.e., short term securities like commercial papers, T-
bills, banker acceptance etc)
– E.g., United money market fund (UMMF)
• People who are not interested in long term growth and want fixed
income after a specific period, so their interest is not price
appreciation
• Example,. Pakistan income fund

Real estate investment funds (REIF): those funds that invest in

the development of land and property
• E.g.,

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 Types of Mutual Funds
Fund of funds (FOF): those funds that invest only in units of other
funds
– E.g., Atlas fund of funds

Vulture funds: those funds that invest only in those companies’

shares which are in financial distress
• No such funds exist in Pakistan because in Pakistan most
companies are family owned and one cannot take over the
company
• These funds take high level of risk

Index funds: invest only in those companies which are listed on

stock market, thus replicating the stock market index

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 Types of Mutual Funds
Industry funds: those funds that invest in specific industry only
– E.g., PICIC energy fund
– It does not go beyond this specific industry
Hedge funds: those funds that invest in derivatives markets or
those funds that take highly risky position with buying and selling
• No such funds exist in Pakistan because in Pakistan most
companies are family owned and one cannot take over the
company
• These funds take high level of risk

• Islamic funds: those funds that invest in shariah compliant

securities only
– E.g., Meezan Islamic Fund (MIF)

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 Performance Evaluation of Mutual Funds
Sharpe Ratio:
is a measure of the excess return (or risk premium) per unit
of total risk
• Or A ratio to measure risk-adjusted performance
• It is calculated by subtracting the risk-free rate from the rate of
return for a portfolio and dividing the result by the standard
deviation of the portfolio’s excess return

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 Performance Evaluation of Mutual Funds
Treynor Ratio:
is a measure of the excess return (or risk premium) per unit
of systematic risk
• Treynor argued that total risk is equal to the sum of systematic
risk and unsystematic risk, and, as unsystematic risk can be
eliminated through diversification, so we should consider only
systematic risk, i.e., beta

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 Performance Evaluation of Mutual Funds
Sortino Ratio:
The Sortino ratio is a variation of the Sharp ratio that
differentiates harmful volatility from total overall volatility by using
the asset's standard deviation of negative portfolio returns, called
downside deviation, instead of the total standard deviation of
portfolio returns

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 How to decide where and how to invest?

• For this purpose we need a careful assessment of all the

investment avenues
• There are two ways for this evaluation:
– Fundamental analysis
• Balance sheet ratios
• Profit and loss ratios
• Profitability ratios
• Liquidity ratios
• Operation efficiency
• Solvency
• Bankruptcy

– Technical analysis

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 How to decide where and how to invest?

• Fundamental Analysis: determining value of a company by

analyzing the fundamental financial statements of a company
(e.g., balance sheet, cash flow statement, profit and loss
statement)

• Technical Analysis: is a process of security analysis discipline

for forecasting the direction of prices through the study of past
market data, primarily price and volume.
• Technical analysts say that you should take decision only when
there is trend or pattern
• Analysts use various tools and techniques to identify trends and
patterns which can aid in predictions of future market movements

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 The Efficient Market Hypothesis (EMH)
• EMH evolved in the 1960’s from the PhD dissertation of Eugene
Fama
• Fama persuasively made the argument that in an active market
that includes many well-informed and intelligent investors,
securities will be appropriately priced and reflect all available
information
• If a market is efficient, no information or analysis can be
expected to result in outperformance of an appropriate
benchmark
• Market adjust prices on the arrival of new information
• Arrival of new information is random, so the movement in prices
is random
• Today’s price reflect all the information

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 The three forms of Market Efficiency
• Fama divided the market efficiency into three forms:
– Weak form efficiency
– Semi-strong form efficiency
– Strong form efficiency
• Weak form efficiency: the theory that security prices reflect all
market data referring to all past price and volume trading
information.
– Therefore, technical analysis can not be used to predict and beat a market
• Semi-strong form efficiency: the theory that security prices
reflect all publicly known and available information
– Therefore, neither fundamental nor technical analysis can be used to
predict and beat a market

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 The three forms of Market Efficiency

• Strong form efficiency: the theory that security prices reflect all
information, which includes both public and private information
– Therefore, not only fundamental and technical analysis, but even inside
information could give investor no advantage to predict and beat a market

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