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Thriving mutual funds industry can lead economy grow up

[dropcap]M[/dropcap]utual funds play an essential role for channelizing and optimal allocation of idle resources/savings available in the economy of the individual as well as institutional investors. The mutual funds are asset management companies, which invest in stocks, bonds and other types of money market or combination of these securities. The primary goal of mutual fund is pool small savings, use the idle resources in corporations and invest in a well-diversified portfolio of securities, which would allow the investor to significantly reduce, or even eliminate the asset specific (non-market) risk of securities. The presence of these mutual funds becomes even more essential when the investors/savers do not have much investment knowledge, information and investment climate and facilities as well as have low risk tolerance level, which is a very dominant characteristic of Pakistani capital market. Increased number of mutual funds all over the world, mainly in developed countries, is an indication of investors’ preference for this indirect mode of low-risk investment.

During the past few decades, the mutual fund industry has experienced a tremendous growth, whereas, mutual fund is still a recent phenomenon in emerging markets. This tremendous growth has led to the creation of various types of mutual funds. These types can be categorized in two broad segments: open-ended and close-ended. The open-ended funds are the funds whose redemption and subscription of shares, which are also called units, is allowed on continual basis. These funds are also characterized as having no customers but the shareholders only. The close-ended funds, on the other hand, all called up and subscribed only once at the commencement of the fund and then traded in the secondary capital markets between the general public. In general, the mutual funds are established and incorporated to benefit small investors who cannot invest directly in money market or capital market securities due to any reason discussed earlier. For this purpose, mutual funds are incorporated under the umbrella of an asset management company which is also called mutual fund group or family.

The history of mutual funds in Pakistan is as old as 1962, when units of National Investment Trust were first offered to public, which is up till now, the only open-ended mutual fund of public sector operating in Pakistan. Afterwards, with the commencement of Investment Corporation of Pakistan, series of close-ended mutual funds were offered to general public, and later on, it was privatized in June 2000.

Although, Pakistan has experienced a phenomenal growth in mutual funds industry with ratio of locally domiciled fund industry assets to GDP increased from 17.55% in 2012 to 25.64% in 2016. However, this domestic industry is still in tiny size as compared to other regional mutual fund industries, which means Pakistan’s mutual fund industry has significant room to grow.

The mutual funds industry of Pakistan has received vast amount of attention. Mutual funds have been working as investment vehicle not only for individual but also for institutional investor due to the fact that they are managed by professionals. It is very often claimed by the mutual funds managers that they have efficient portfolio. Despite huge global and local financial setback in 2008, mutual fund industry suffered less by the global and domestic financial recession as compared to some other financial sectors.

Investing in mutual provides liquidity, diversification and variety to the investment. Limited research has been conducted on the mutual funds industry of Pakistan. Whereas, the industry is going through emerging phase therefore extensive research is required.

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The liquidity ratio has significant impact on the performance of mutual funds. The size of the asset should not be considered to find out the superiority or inferiority of mutual fund in Pakistan. The mutual funds usually underperform due to problem of diversification. The mutual fund management must disclose the level of risk associated with the investment so that investors can make decision about the real performance.

The ranking of the mutual funds changed frequently due to fluctuation in the capital market in Pakistan. This volatile behavior is not suitable especially for the closed ended mutual funds. It also indicates that mutual funds industry is on flourishing phase. Most of the equity mutual funds in Pakistan holds large cap portfolio rather than holding value oriented portfolio.

The performance of such mutual funds is inconsistent. These mutual would bear extreme negative returns during bearish trend in the market. The expense ratio and asset turnover has positive relation with growth of mutual funds industry in Pakistan. Whereas, management fee and risk adjusted returns are negatively related with growth of mutual funds.

MODARABA SECTOR

Modaraba sector is unique form of Islamic finance that was started in 1980 in the country. Currently it is catering to a wide range of Shariah-compliant businesses, including leasing, manufacturing, trading, and financial services. SME and halal food are two promising segments for the sector. Recent reforms and strengthening of regulatory framework by the Securities and Exchange Commission of Pakistan (SECP) has pushed up modaraba sector’s asset base by 11 percent to Rs41 billion in six months ending Dec 2016. The SECP is currently working on amending the modaraba law to further strengthen the regulatory framework and safeguard investors’ interests. Serious damage to sector was caused by the ‘modaraba scam’ caused by unregulated elements that were not subjected to checks and balances applicable to the formal sector.

The increase in assets indicated a growth of 11.41 percent from June 2016; when the total assets of the modaraba sector were recorded at Rs36.8 billion. Listed Islamic banks have 25,000 shareholders whereas modaraba sector has around 80,000 investors.The growth in the sector was due to low level of leverage, healthy dividend payouts and other tax incentives available to sector. The income of a modaraba is exempt from tax if it distributes 90 percent of its profit.

Majority of modarabas regularly distribute profits to certificate holders.Though the sector has managed to shake off its lackluster image and moved to the forefront of non-banking financial institution (NBFI) segment, one of the key challenges is its concentration in a few large cities.

[box type=”info” align=”” class=”” width=””]The writer is a Karachi-based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan[/box]

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