Professional Documents
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REPORT
MUTUAL FUNDS
➢ Introduction-------------------------------------------- 4
➢ History------------------------------------------------ 4
➢ Types of Mutual Fund------------------------------------ 5
➢ Advantages of Mutual Fund------------------------------- 7
➢ Disadvantages of Mutual Fund ---------------------------- 9
➢ History of Mutual Funds in Pakistan------------------------- 11
INTRODUCTION
A mutual fund is a form of collective investment that pools money from many
investors and invests their money in stocks, bonds, short-term money market
instruments, and/or other securities. In a mutual fund, the fund manager trades the
fund's underlying securities, realizing capital gains or losses, and collects the
dividend or interest income. The investment proceeds are then passed along to the
individual investors. The value of a share of the mutual fund, known as the net
asset value per share (NAV), is calculated daily based on the total value of the fund
divided by the number of shares currently issued and outstanding.
Mutual funds can invest in many different kinds of securities. The most common are
cash, stock, and bonds, but there are hundreds of sub-categories. Stock funds, for
instance, can invest primarily in the shares of a particular industry, such as
technology or utilities. These are known as sector funds. Bond funds can vary
according to risk (e.g., high-yield or junk bonds, investment-grade corporate bonds),
type of issuers
Most mutual funds' investment portfolios are continually adjusted under the
supervision of a professional manager, who forecasts the future performance of
investments appropriate for the fund and chooses those which he or she believes
will most closely match the fund's stated investment objective. A mutual fund is
administered through a parent management company, which may hire or fire fund
managers.
Mutual funds are liable to a special set of regulatory, accounting, and tax rules.
Unlike most other types of business entities, they are not taxed on their income as
long as they distribute substantially all of it to their shareholders. Also, the type of
income they earn is often unchanged as it passes through to the shareholders.
Mutual fund distributions of tax-free municipal bond income are also tax-free to the
shareholder. Taxable distributions can be either ordinary income or capital gains,
depending on how the fund earned those distributions.
OPEN END
Open mutual funds are established by a fund sponsor, usually a mutual fund
company. The sponsor has promised in the documents of the fund that it will issue
and refund or units of the fund at the fund unit value. This type of fund is valued by
the fund company or an outside valuation agent. This means that the investments
of the fund are valued at "fair market" value, which is the closing market value for
listed public securities. Essentially, the fund company prices all of the fund's
holdings at the market close and adds up their value; it then subtracts amounts
owing and adds amounts to be received by the fund; and finally it divides this net
amount by the number of units outstanding to "strike" the unit value for that day.
Any participants withdrawing funds from the fund that day receive this unit value
for their funds withdrawn. Any new purchases are made at the same unit value.
Open mutual funds keep some portion of their assets in short-term and money
market securities to provide available funds for redemptions. A large portion of
most open mutual funds is invested in highly "liquid securities", which means that
the fund can raise money by selling securities at prices very close to those used for
valuations. Funds also have the ability to borrow money for short periods of time to
fund redemptions. The documents of open mutual funds usually provide for the
suspension of unit redemptions in "extraordinary conditions" such as major
interruptions to the financial markets or total demands for redemptions forming a
substantial portion of the fund assets in a short period of time. These clauses were
invoked in October, 1987, when the stock market crashed 30% in a few days and
the volume of stock transactions caused trading activity to be hours out date.
Illiquid investments, those not actively traded on the public markets, are restricted
by government regulators because they are difficult to dispose of in a short period
of time. A fund holding an illiquid investment might not be able to sell it in a short
period of time or would have to take a significant discount to the valuation level the
fund was using. In Canada, most open real estate mutual funds suspended
redemptions during the real estate debacle of the early 1990s. Fund participants did
not obtain redeemed funds until these funds were restructured into closed-end
funds in the mid 1990s and they could sell their units on the stock market.
The valuation of investments that are less liquid and trade infrequently is an
important issue for mutual funds.
CLOSE END
Closed mutual funds are really financial securities that are traded on the stock
market. A sponsor, a mutual fund company or investment dealer, will create a "trust
fund" that raises funds through an underwriting to be invested in a specific fashion.
The fund retains an investment manager to manage the fund assets in the manner
specified. A good example of this type of fund is the "country funds" that were
underwritten during the international investment euphoria of the early 1990s. An
investment dealer would decide that a "Germany" or "Portugal" or "Emerging
Country" fund would sell given the popular consensus that these were "no lose"
investments. It would then retain a well respected investment advisor to manage
the fund assets for a fee and underwrite a public issue that it would sell through
retail stock brokers to individual investors. It is interesting to note that many of
these funds were caught in the sell-off of the stock market of 1994 and have
languished ever since. This has led to the phrase "submerging country" replacing
"emerging market" for many of these funds. This is wry proof of the fickleness of
investor fashion!
Once underwritten, closed mutual funds trade on stock exchanges like stocks or
bonds. Their value is what investors will pay for them. Usually closed mutual funds
are traded at discounts to their underlying asset value. For example, if the price of
the fund assets less liabilities divided by the outstanding units is $10, the fund
might trade on the stock market at $9. This fund would be said to be trading at a
"10% discount to its net asset value". The reason for this discount is debated by
academics, but is due in large part to the lack of liquidity of the fund units and the
presence of the management fee.
ADVANTAGES OF MUTUAL FUNDS
Mutual funds offer a number of advantages, including diversification, professional management,
cost efficiency and liquidity.
• Diversification. A mutual fund spreads your investment dollars around
better than you could do by yourself. This diversification tends to lower the
risk of losing money. Diversification usually results in lower volatility, because
when some investments are doing poorly, others may be doing well.
• Liquidity. With most funds, you can easily sell your fund shares for cash.
Some mutual fund shares are traded only once a day at a fixed price, while
stocks and bonds can be bought or sold any time the markets are open at
whatever price is then available.
• Choice: Mutual funds come in a wide variety of types. Some mutual funds
invest exclusively in a particular sector (e.g. energy funds), while others
might target growth opportunities in general. There are thousands of funds,
and each has its own objectives and focus. The key is for you to find the
mutual funds that most closely match your own particular investment
objectives
• Low Investment Minimums: Most mutual funds will allow you to buy into
the fund with as little $1,000 or $2,000, and some funds even allow a "no
minimum" initial investment, if you agree to make regular monthly
contributions of $50 or $100. Whatever the case may be, you do not need to
be exceptionally wealthy in order to invest in a mutual fund.
• Convenience: When you own a mutual fund, you don't need to worry about
tracking the dozens of different securities in which the fund invests; rather,
all you need to do is to keep track of the fund's performance. It's also quite
easy to make monthly contributions to mutual funds and to buy and sell
shares in them.
• Low Transaction Costs: Mutual funds are able to keep transaction costs --
that is, the costs associated with buying and selling securities -- at a
minimum because they benefit from reduced brokerage commissions for
buying and selling large quantities of investments at a single time. Of course,
this benefit is reduced somewhat by the fact that they are buying and selling
a large number of different stocks. Annual fees of 1.0% to 1.5% of the
investment amount are typical
.
• Regulation: Mutual funds are regulated by the government under the
Investment Company Act of 1940. This act requires that mutual funds
register their securities with the Securities and Exchange Commission. The
act also regulates the way that mutual funds approach new investors and the
way that they conduct their internal operations. This provides some level of
safety to you, although you should be aware that the investments are not
guaranteed by anyone and that they can (and often do) decline in value.
• Price Uncertainty — With an individual stock, you can obtain real-time (or
close to real-time) pricing information with relative ease by checking financial
websites or by calling your broker. You can also monitor how a stock's price
changes from hour to hour — or even second to second. By contrast, with a
mutual fund, the price at which you purchase or redeem shares will typically
depend on the fund's NAV, which the fund might not calculate until many
hours after you've placed your order. In general, mutual funds must calculate
their NAV at least once every business day, typically after the major U.S.
exchanges close
.
• No Insurance: Mutual funds, although are regulated by the government, are
not insured against losses. The Federal Deposit Insurance Corporation (FDIC)
only insures against certain losses at banks, credit unions, and savings and
loans, not mutual funds. That means that despite the risk-reducing
diversification benefits provided by mutual funds, losses can occur, and it is
possible (although extremely unlikely) that you could even lose your entire
investment.
• Loss of Control: The managers of mutual funds make all of the decisions
about which securities to buy and sell and when to do so. This can make it
difficult for you when trying to manage your portfolio. For example, the tax
consequences of a decision by the manager to buy or sell an asset at a
certain time might not be optimal for you. You also should remember that
you are trusting someone else with your money when you invest in a mutual
fund.
• Size: Some mutual funds are too big to find enough good investments. This is
especially true of funds that focus on small companies, given that there are
strict rules about how much of a single company a fund may own. If a mutual
fund has $5 billion to invest and is only able to invest an average of $50
million in each, then it needs to find at least 100 such companies to invest in;
as a result, the fund might be forced to lower its standards when selecting
companies to invest in
.
• Inefficiency of Cash Reserves: Mutual funds usually maintain large cash
reserves as protection against a large number of simultaneous withdrawals.
Although this provides investors with liquidity, it means that some of the
fund's money is invested in cash instead of assets, which tends to lower the
investor's potential return.
Different Types: The advantages and disadvantages listed above apply to mutual
funds in general. However, there are over 10,000 mutual funds in operation, and
these funds vary greatly according to investment objective, size, strategy, and
style. Mutual funds are available for virtually every investment strategy (e.g. value,
growth), every sector (e.g. biotech, internet), and every country or region of the
world. So even the process of selecting a fund can be tedious
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. Now many private sectors are also getting into the
industry.
Early 90’s capital market upsurge à private sector Mutual Fund’s launched
1996 to 2000 Mutual Fund’s suffered badly due to lack of investment philosophy
INDUSTRY COMPOSITION
NUMBER OF OPEN ENDED FUNDS
FUNDS FY08 FY07
Asset Allocation 5 4
Balanced 5 3
Bond 2 3
Capital Protected 5 2
Equity 14 10
Funds of Funds 1 2
Income 21 14
Index Tracker 2 2
Money Market 6 5
Islamic Balanced 1 0
Islamic Capital 1 0
Protected
Islamic Equity 3 3
Islamic Income 6 4
TOTAL 77 55
FUNDS FY 08 FY 07
Balanced 4 2
Capital Protected 3 1
Equity 11 11
Funds of Fund 1 1
Income 1 1
Islamic Balanced 1 1
Islamic Equity 2 2
TOTAL 23 19