What is Mutual Fund?

Amir Aizaz
Secretary
Mutual Funds Association of Pakistan - MUFAP

Once you've decided to invest in the stock market, mutual funds are an easy way
to own stocks without worrying about choosing individual stocks. As an added
bonus, you can find plenty of information on the Internet www.mufap.com
to help you learn about, study, select, and purchase them.
But what is mutual fund? It's not complicated.

A mutual fund is managed by a management company. The management

company is a bank of human resources, considered to be professionally qualified
personnel. The portfolio of mutual fund is managed by a "Portfolio Manager",
whose responsibility is to be invested in, and satisfies the desire of the investors.
While selecting the securities for investment, these managers analyze economic
conditions, industry trends, government regulations and their impact on the
stocks, and forecasts for the specific stocks to the project the future outcome
generated by the companies. As we all know that the economic and business
condition do not remain constant, so these managers also revise their portfolio
with the passage of time, as the circumstances demand.

Concept of Mutual Funds:

The concept is very simple, small investors invest their money into a common
pool or fund and hand over the investment decision to fund manager/ portfolio
manager. This is expected to have several advantages for the small investors: no
more searching for good buys or relying on the neighborhood sub-broker for
advice or even waiting anxiously for the allotment. All this is taken care of by the
cumulative bargaining power of the fund, which has trained professionals
managing it.

Every day, the fund manager/ portfolio manager counts up the value of all
fund's holding, figures out how many shares have been purchased by
shareholders, and then calculates the Net Asset Value (NAV) of the mutual fund,
the price of a single share of the fund on that day. If you want to buy shares, you
just send the manager your money, and they will issue new shares for you at the
most recent price.

1
If the fund manager is doing good job, the NAV of the fund will usually get
bigger your shares will be worth more.

Types of Mutual Funds:

There are two types of mutual funds, which are:

• Open-end mutual funds

• Closed-end mutual funds

OPEN-ENDED MUTUAL FUND:

Open-end mutual funds are those where subscription and redemption of shares
are allowed on a continues basis. The price at which the shares of open-end
funds offered for subscription and redemption is determined by the NAV after
adjusting for any sales load or redemption fee. In Pakistan there exists thirteen
open ended mutual funds; National Investment (Unit) Trust (NIT) in the public
sector and Atlas Income Fund, Crosby Dragon Fund, Faysal Balanced Growth
Fund, Dawood Money Market Fund, Pakistan Income Fund, Pakistan Stock
Market Fund, MetroBank-Pakistan Sovereign Fund, Meezan Islamic Fund, Unit
Trust of Pakistan, UTP Income Fund, UTP Islamic Fund and United Money
Market Fund in private sector.

CLOSED-END MUTUAL FUND:

Closed-end mutual funds are those where the shares are initially offered to the
public and are then traded in the secondary market. The trading usually occurs
at a slight discount to the NAV.

Over a period of time, the mutual fund managers have developed a variety of
investment products to cater for the requirement of investors, having different
needs. These include:

• GROWTH FUNDS
• BALANCED FUNDS
• INCOME FUNDS

GROWTH FUNDS

The "growth funds" offer potential for appreciation in share value, while the
current income may be low. The fluctuation in share price may also be high. Such
funds invest in stocks and have tendency to outperform other funds and other
modes of savings over a period of time.

BALANCED FUNDS
2
The "growth and income funds" or "balanced funds", offer prospects of both
moderate appreciations in share value as well as current income. The fluctuation
in share price may be low. Such funds invest in stocks, corporate debts and
Government paper.

INCOME FUNDS

The "bond fund" or "income funds", offer good current income but very little
potential for growth. Such funds invest in government paper, bonds issued
by municipal or local bodies, corporate debts and in stocks of utility companies,
offering regular return.

SOURCES OF PROFIT GENERATION:

A mutual fund can generate profits from three different sources, which are:
• Dividend
• Capital Gains
• Appreciation of Share Price

Dividend:

Mutual fund generates income from dividends received from other joint stock
companies whose shares the fund holds. A mutual fund uses this dividend
income to distribute dividend to its own stock holders.

Capital Gains:

As discussed earlier the portfolio manager changes the portfolio of the fund with
the passage of the time and also with the changes in economic and business
conditions. So due to the sale and purchase of shares, the mutual fund generates
capital from the sales/ purchase of stocks. The capital gain generated by the
mutual fund is also used to pay dividends to the investors of the fund.

Appreciation of Share Price:

Mutual funds also increase the wealth/investment of their shareholder through

appreciations of share price of the mutual fund. For example if the subscription
price of a mutual fund is Rs.11.00, and after a period of seven months the price
goes upto Rs.18.00, thus the investor gets a profit of Rs.7.00 if he sell the mutual
fund's shares in the market.

Advantages of Mutual Funds:

3
 • Mutual Funds substantially lower the investment risk of small investors
through diversification in which funds are spread out into various sectors,
companies, securities as well as entirely different markets. It is always the
objectives of a fund manager to maximize a funds return for a given level
of risk, however the dangers of "over-diversification" are always prevalent
which would inevitably lead to a reduced return on the portfolio.
• Mutual Funds mobilize the saving of small investors and channel them
into lucrative investment opportunities. As a result, mutual funds add
liquidity to the market. Moreover, given that the funds are long term
investment vehicles, they reduce market volatility by offering support to
scrip prices.
• Mutual Funds are providing the small investor access to the whole market
which individually, would be difficult to achieve.
• The investors save a great deal in transaction cost given that he has access
to a large number of securities by purchasing a single share of mutual
fund.
• The investors can pick and choose a mutual fund to match his particular
needs.

Disadvantages of Mutual Funds:

As such there is no major disadvantage attached to the mutual funds. However,
the possible disadvantages could be:

• Economic and Business Conditions: As the business and economic

conditions do not remain constant, the mutual fund may face some
difficulties in future. Especially if the manager does not shuffle the
investment portfolio with the passage of time, or some other major
unforeseen disaster/event changes the investment scenario.
• Portfolio Managed by Managers: Portfolio of a mutual fund is managed
by the portfolio managers due to which the investor has no say in the
affairs of a mutual fund.

History of Mutual Funds in Pakistan:

Mutual Funds were introduced in Pakistan in 1962, with the public offering of
National Investment (Unit) Trust (NIT) which is an open-end mutual fund in
the public sector. This was followed by the establishment of the Investment
Corporation of Pakistan (ICP) in 1966, which subsequently offered a series of
closed-end mutual funds.

Currently there exists one open end (NIT) mutual fund in public sector. Twelve
open-ended and Fourteen closed-ended mutual funds under private sector
management, and there are many more Funds in the pipeline.

4
Rules Govern Mutual Funds in Pakistan

There are two rules govern mutual funds in Pakistan, which are:

1. Investment Companies and Investment Advisors' Rules, 1971. (govern

closed-end mutual funds)
2. Asset Management Companies Rules, 1995. (govern open-ended mutual
funds)

Mutual Funds in Pakistan:

Open-end Closed-end
Public --
Sector 1. National Investment Trust
2. Atlas Income Fund 1. Al-Meezan Mutual Fund
3. Crosby Dragon Fund 2. Asian Stocks Fund
4. Faysal Balanced Growth Fund 3. ABAMCO Composite Fund
5. Dawood Money Market Fund 4. ABAMCO Capital Fund
6. Pakistan Income Fund 5. ABAMCO Stock Market Fund
Private 7. Pakistan Stock Market Fund
6. 4th ICP Mutual Fund
8. MetroBank-Pak Sovereign Fund
Sector 7. BSJS Balanced Fund
9. Meezan Islamic Fund
10. Unit Trust of Pakistan 8. Dominion Stock Fund
11. UTP Income Fund 9. First Capital Mutual Fund
12. UTP Islamic Fund 10. Golden Arrow Stock Fund
13. United Money Market Fund 11. Investec Mutual Fund
12. ICP SEMF managed by PICIC
13. PICIC Investment Fund (ICP Lot ‘B’)
14. Pakistan Premier Fund
15. Pakistan Capital Market Fund
16. Prudential Stock Fund
17. Safeway Mutual Fund
18. Tri-Star Mutual Fund

(This article is written by Mr. Amir Aizaz, Secretary Mutual Funds Association of
Pakistan – MUFAP. Mr. Amir Aizaz holds Masters Degree (MBA). He joined MUFAP
in 1996.)